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Five Reasons to Sell Abercrombie Now

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Company's troubles can't be chalked up to retail headwinds alone.

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Abercrombie & Fitch (ANF) may flaunt its sexy brand image, but there's nothing sexy about its business these days.

On Friday, the teen retailer posted a quarterly report that was disastrous from top to bottom. Plunging revenue in all 4 of its segments instigated drastic promotional activity -- which ultimately led to margin erosion and a quarterly loss.

Granted, the entire retail industry is currently facing unprecedented consumer spending weakness, so sales declines and margin contraction isn't all that surprising. However, Abercrombie's problems extend far beyond the macro environment. I'm giving a thumbs down on this retail play.

Here's why.

1. Abercrombie is clearly losing market share. It reported a 23% drop in revenue in the second quarter and a 30% decline in comps. Meanwhile, rival American Eagle (AEO) reported a 4.4% decline in sales last quarter. Even Gap (GPS) and Pacific Sunwear (PSUN) -- 2 retailers with company-specific problems of their own -- reported a 7.6% and 16.3% decline, respectively, in the last quarter.

Abercrombie's performance is notably worse than its competitors, which is a sign that it's beset by far more than just general spending trends and that it's market share is shrinking.

2. Heading into this recession, management stood firm on its decision to maintain price points in order to retain its premium brand image. However, it has obviously abandoned the strategy; the gross profit margin fell 360 basis points due to promotional activity and the company announced its plan to reduce average prices.

By boasting superior gross margins, Abercrombie believed it could handle a temporarily collapse in sales from keeping high price points to avoid tarnishing its brand. But Abercrombie's high-cost structure has always resulted in inferior operating margins to lower priced competitors like American Eagle.

The company has never operated on a lean business model, so it's impossible for it to leverage declining revenue without drastically reducing prices. Abercrombie is working hard to reduce costs. In my opinion, however, it's too late, and the company should have been running leaner operations before this mess began.

Abercrombie has therefore fallen into the same trap that many of its rivals have: Lowering prices to beg consumers to step foot in a store.
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Position in AEO
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