Profitability and Growth Analysis of Abercrombie and Fitch - Case Study Example

Retrospective Analysis Contents Introduction 3 Profitability and Growth Analysis of Abercrombie and Fitch 4 Profitability and Growth Analysis of Gap Inc 7 Conclusion 9 References 10 Lim, P. J (2014). Stocks Plunge Wednesday on Global Economic Fears. TIME. Accessed online at < http://time.com/money/3501902/stocks-plunge-global-economic-fears/> [15th October, 2014] 11 Nasdaq (2014a). Abercrombie and Fitch Company Financials. Nasdaq.com. Accessed online at < http://www.nasdaq.com/symbol/anf/financials?query=ratios> [16th October, 2014] 12 Nasdaq (2014b). Gap Inc. Company Financials. Nasdaq.com. Accessed online at [16th October, 2014] 12 Nasdaq (2014c). Abercrombie and Fitch. Nasdaq.com. Accessed online at [28th October, 2014] 12 Temin, D. (2014). How A CEO Can Wreck A Brand In One Interview: Lessons From Abercrombie & Fitch Vs. Dove. Forbes. Accessed online at < http://www.forbes.com/sites/daviatemin/2013/05/13/abercrombie-and-fitch-v-dove-or-how-a-ceo-can-wreck-a-brand-in-1-interview-7-years-ago/> [16th October, 2014] 13 Introduction Financial performance is a substantial and critical part of overall retail strategy as it guides the progress of future strategic decision making in a company and provides a guideline for assessing trends (Reynolds, Cuthbertson and Bell, 2004). Moreover, the assessment of financial performance as represented by ratios, profitability and sales volume also acts as an indicator of informing a business regarding the customers’ responses to a particular product or new launch (Dune, Lusch and Carver, 2013). This in turn allows the company to evaluate future financial prospects and the level of competitiveness which has been attained during a given period. Consequently, a comparative examination of profitability measures and ratios can enable companies to comprehend their position within the wider sphere of the industry. Furthermore, the analysis regarding profitability also guides the company’s direction in terms of meeting corporate objectives such as growth and expansion into foreign markets. This aspect is of tremendous significance in the context of retailing in a highly globalized business environment as casual and edgy apparel is becoming increasingly popular across the globe. Increased profitability therefore, is not only indicative of a positive customer response but also enables companies to raise sufficient capital for financing a move to other locations. The aforementioned elements are reflective of the notion of whether a company has been able to create value or destroy value over a period of time. The discussion which has been conducted in this report focuses on conducting a comprehensive profitability and growth analysis of retailing giants Abercrombie and Fitch and GAP Inc over a period of the last five years to conclude whether the companies have created or destroyed value during the span. The assessment incorporates relevant indicators of profitability and growth such as ratios to provide objective and applicable conclusions. Profitability and Growth Analysis of Abercrombie and Fitch This section of the report assesses the profitability and growth prospects of Abercrombie and Fitch during the period between 2010 and 2014. Recent data reporting U.S retail sales for the month of September, has shocked financial analysts by posting a 0.3% decline in overall retail sales volume across the nation which has indeed proven to be unexpected (Lim, 2014; Kennedy and Mayeda, 2014). The reports of such retailing performances recorded in the past month have essentially conflicted with the expectations that retail sales would rise in coming months thereby, concerning analysts. As noted by Kennedy and Mayeda (2014), the drop in retail performance during the past month has even emerged as “the latest catalyst of concern” for investors. Amidst these reports, Abercrombie and Fitch’s financial review is a critical priority for the company’s managers to direct the business from a potential crisis which essentially occurred between the period of 2013 and 2014. The following table presents the sales volume or revenue generation for the firm from 2010 and 2014 to outline the trends that the company has experienced. 2009 2010 2011 2012 2013 2014 Sales Revenue 3.54B 2.93B 3.47B 4.16B 4.51B 4.12B Gross Margin 66.7 64.3% 64% 61% 62% 63% Profitability Margin 12.5% 4% 7% 5% 8% 2% (Source: Marketwatch.com, 2014a and Morningstar financials, 2014) The data presented in the table above suggests that in the period between 2010 and 2013, the company reported a consistent and positive increase in sales revenue which grew by 1.58B during the years. However, in the year 2014 the company reported a sharp decline in sales revenue thereby, ending the rising trend in sales figures. According to Prior and Rubin (2014), the company attributed its decline in profits during 2014 to the lack of response received from its female teenaged audience which has subsequently led to the shrinking size of the company’s customers. The examination of profitability cannot be completed without adding the aspect of a company’s cost and expenditures, the table below shows the expenses incurred by the company between 2010 and 2014. 2010 2011 2012 2013 2014 SG&A Expenses 1.54B 1.71B 1.98B 2.23B 2.15B (Source: Marketwatch.com, 2014a) The five year trend featuring the company’s expenses reports that the company’s costs rose between 2010 and 2013, while, the company was able to cut back on these expenses in 2014. It should be noted that the cost cutting measure imposed during 2014 corresponds with a significant decline in the retailer’s sales volume during the same year. The analysis presented by Prior and Rubin (2014) clarifies that the cost cutting measures initiated during this period are in fact a part of a strategic effort by Abercrombie and Fitch to revive its profitability. Given the highly competitive nature of the retailing world, the company believes that an increase in sales revenue and profitability with specific target to its female clothing line can only be achieved by reducing the average cost per unit to offer competitive prices. Therefore, to enhance the long term health of the business, the company’s senior management has launched these cost cutting measures to increase operational efficiency and revive profit levels. 2010 2011 2012 2013 2014 Current Ratio 275% 258% 223% 189% 232% Quick Ratio 179% 188% 125% 128% 139% Cash Ratio 158% 150% 96% 93% 106% (Source: NASDAQ, 2014c and Morningstar financials, 2014) (Appendix 1) The three liquidity ratios presented in the table above are indicators of the firm’s ability to pay off its short term debt obligations. Generally speaking the higher the ratios, the more secure the company is with regards to its creditors and its debt financing. The three calculated figures all show a similar trend with strong ratios in 2011 which declined in the years 2012 and 2013 but rose again in response to the cost cutting measures undertaken by Abercrombie and Fitch in 2014. The Current ratio is the most popular liquidity indicator measuring current assets against current liabilities; a ratio of 1:1 would indicate that the firm can manage to pay back all its short term debts in a period of 12 months. The high ratios show that the firm is in a safe position with regards to its obligations. The quick ratio (acid-test) is a more stringent test which only takes into account cash and other easily convertible assets in the calculations, while the Cash ratio is the most conservative ratio in the group which also ignores any inventory or receivables of the company as these cannot be converted to cash quickly to pay off short term debt. Since most of the ratios are above 1:1 for Abercrombie and Fitch in these calculations, the company is in a highly safe position regarding debt management. High sales revenue in 2012 and 2013 resulting from sale out of inventory and utilization of current assets are one possible reason for the decrease in the ratios in these years even though they are still strong. However, abnormally high ratios (especially Cash ratio) can also be an indicator of poor resource management by a firm as it shows they have unnecessary cash on hand instead of a higher rate of investment. It is possible that the company will make use of the excess assets as a required financial resource for the new strategy being applied and this will bring back the ratios to a more acceptable level. Profitability and Growth Analysis of Gap Inc Current growth prospects for Gap Inc which recently announced the arrival of new CEO and former head of digital division, Art Peck who is expected to take over in early 2015 marks a transition for the company in terms of redefining its branding policy and shifting its focus towards brands which have been guiding the company’s growth during the past five years (Gottfried, 2014). The following data presents Gap Inc’s recorded sales in the period between 2010 and 2014. 2010 2011 2012 2013 2014 Sales Revenue 14.2B 14.66B 14.55B 15.65B 16.15B Gross Margin 40.3% 40% 36% 39% 39% Operating Margin 12.8% 13% 10% 12% 13% (Source: Marketwatch.com, 2014b, Nasdaq.com, 2014a and Morningstar financials, 2014) Gap Inc’s sales revenue remains consistently favorable and has even reported a rising trend when retailing prospects in the market have been hit by unfavorable economic situations. In comparison with Abercrombie and Fitch, the reported sales revenue for Gap Inc. is significantly higher because the company has extensive and widespread sales divisions and does not operate to serve a concentrated market like Abercrombie and Fitch. Moreover, the company’s recent ventures in retailing have been characterized by the adoption of strategies to expand their business and explore a range of audience rather than serving a restricted clientele like Abercrombie and Fitch. For example, Gap Inc. also manages a clothing division which caters to the production of clothing for babies and maternity clothing for pregnant women. This assertion implies that in comparison with Abercrombie and Fitch, Gap Inc. possesses a greater ability to combat the volatile situation of the market and absorb external shocks which are a consequence of the unpredictable economic conditions. Accordingly, Gap Inc’s management of its overhead costs and other expenditures has also played a critical role in preserving the value of the company in unfavorable economic times, as represented in the table below; 2010 2011 2012 2013 2014 SG&A Expenses 3.92B 3.91B 3.82B 4.23B 4.16B (Source: Marketwatch.com, 2014b, Nasdaq.com, 2014b) The five year data and trend analysis for Gap Inc. reports that the company has been successful in maintaining the level of expenditure and costs by promoting efficiency across departments. Moreover, in the period between 2013 and 2014, the level of expenditure has decreased despite of market observations reporting that retailers have suffered a decline during this period. Gap Inc’s cost cutting measures have been characterized by streamlining brands and flagship stores to identify administrative issues and lead efficiency enhancing frameworks in these areas to successfully address the prospects of declining sales because of a possible economic downturn. Conclusion The analysis which has been conducted in this report incorporates an examination of the profitability and growth prospects of two companies Abercrombie and Fitch and Gap Inc. to identify whether the companies have been able to create value or destroy value in the past five years based on their sales revenue and expenses to identify the level of profit generated and any possible increases in profits in the last five years. The level of profitability has been categorized as a pivotal factor in value creation for it enables companies to receive investor attention and also boost shareholder value creation (Ramezani, Soenen and Jung, 2001; Madden, Fehle and Fournier, 2006). Moreover, in the retail industry the creation of value has also been linked with a high level of customer satisfaction which Gap Inc. has evidently been able to achieve (Anderson, Fornell and Mazvancheryl, 2004). Accordingly value creation is also attributable to building brand loyalty in the sphere of retail (Berry and Carbone, 2007). The report concludes that the scenario regarding the economic forces which have been impacting retailers across the U.S and other parts of the world raises concerns for companies regardless of their size and scale of operation. However, by maximizing value companies can gain customers, increase profitability and also achieve growth. Nonetheless, Abercrombie and Fitch’s restricted approach in catering to its audience and its increasing costs have led to a minimization of value being offered to its customers and shareholders alike (Duprey, 2014). Therefore, the business has been losing its appeal and brand image amongst the younger audience. On the other hand, Gap Inc. has expanded its brands and clothing lines into toddler, baby and maternity clothes division to encourage a rise in sales revenue while, working on managing an efficient supply chain to reduce costs (Worley, Feyerherm and Knudsen, 2010). This in addition to the placement of effective cost cutting measures has allowed the company to create value and successfully compete in the retail industry by promoting the current ownership of its brands and launching new product lines. References Anderson, E. W., Fornell, C., & Mazvancheryl, S. K. (2004). Customer satisfaction and shareholder value. Journal of Marketing, 68(4), 172-185. Berry, L. L., & Carbone, L. P. (2007). Build loyalty through experience management. Quality progress, 40(9), 26. Dunne, P., Lusch, R., & Carver, J. (2013). Retailing. Cengage Learning. Kennedy, S . an d Mayeda, A. (2014). World Economy Gives Investors Growth Scare as They Look to U.S. Bloomberg. Accessed online at [15th October 2014] Lim, P. J (2014). Stocks Plunge Wednesday on Global Economic Fears. TIME. Accessed online at < http://time.com/money/3501902/stocks-plunge-global-economic-fears/> [15th October, 2014] Madden, T. J., Fehle, F., & Fournier, S. (2006). Brands matter: an empirical demonstration of the creation of shareholder value through branding. Journal of the Academy of Marketing Science, 34(2), 224-235. Marketwatch (2014a). The Gap Annual Financials. Marketwatch.com. Accessed online at < http://www.marketwatch.com/investing/stock/gps/financials> [15th October, 2014] Marketwatch (2014b). Abercrombie and Fitch Annual Financials. Marketwatch.com. Accessed online at < http://www.marketwatch.com/Companies/Abercrombie_Fitch_Co> [15th October, 2014] Morningstar Financials, (2014). Abercrombie & Fitch Co Class A ANF. Accessed online at < http://financials.morningstar.com/ratios/r.html?t=ANF®ion=usa&culture=en-US> [15th October, 2014] Morningstar Financials, (2014). Gap Inc GPS. Accessed online at < http://financials.morningstar.com/ratios/r.html?t=GPS> [15th October, 2014] Nasdaq (2014a). Abercrombie and Fitch Company Financials. Nasdaq.com. Accessed online at < http://www.nasdaq.com/symbol/anf/financials?query=ratios> [16th October, 2014] Nasdaq (2014b). Gap Inc. Company Financials. Nasdaq.com. Accessed online at [16th October, 2014] Nasdaq (2014c). Abercrombie and Fitch. Nasdaq.com. Accessed online at [28th October, 2014] Prior, A. and Rubin, F. B (2014). Abercrombie & Fitchs Profit Falls Board Approves Share-Repurchase Plan. Wall Street Journal. Accessed online at [15th October, 2014] Ramezani, C. A., Soenen, L. A., & Jung, A. R. (2001). Growth, corporate profitability, and shareholder value creation. Available at SSRN 304880. Reynolds, J., Cuthbertson, C., & Bell, R. (Eds.). (2004). Retail strategy: the view from the bridge. Routledge. Temin, D. (2014). How A CEO Can Wreck A Brand In One Interview: Lessons From Abercrombie & Fitch Vs. Dove. Forbes. Accessed online at < http://www.forbes.com/sites/daviatemin/2013/05/13/abercrombie-and-fitch-v-dove-or-how-a-ceo-can-wreck-a-brand-in-1-interview-7-years-ago/> [16th October, 2014] Worley, C. G., Feyerherm, A. E., & Knudsen, D. (2010). Building a collaboration capability for sustainability: How Gap Inc. is creating and leveraging a strategic asset. Organizational Dynamics, 39(4), 325-334. Appendix 1 Formulas for calculating the financial ratios: 1. Current Ratio: Current Assets/ Current Liabilities 2. Quick Ratio= (Cash in Hand + Cash at Bank + Receivables + Marketable Securities )/ Current Liabilities 3. Cash Ratio= (Cash+ Cash Equivalents)/ Current liabilities These ratios are calculated from balance sheet figures and then presented as percentages. Read More