Motley Fool Money - Not Your Older Cousin’s Abercrombie

Episode Date: August 23, 2023

Abercrombie is back in vogue, but be careful chasing this cyclical business.  (00:21) Jason Moser and Dylan Lewis discuss: - The reality of Peloton’s seasonality, and how the company is doing with its recalls and digital ambitions.  - At all-time lows, is Peloton more interesting? - How Abercrombie’s back in vogue, and what the retailer is doing to connect with consumers in a tough retail environment.  Companies discussed: PTON, ANF Host: Dylan Lewis Guests: Jason Moser Engineers: Dan Boyd  Learn more about your ad choices. Visit megaphone.fm/adchoices

Hi everyone, I'm Charlie Cox. Join us on Disney Plus as we talk with the cast and crew of Marvel Television's Daredevil Born Again. What haven't you gotten to do as Daredevil? Being the Avengers. Charlie and Vincent came to play. I get emotional when I think about it. One of the great finale of any episode we've ever done. We are going to play Truth or Daredevil.

What? Oh, boy. Fantastic. You guys go hard. Daredevil Born Again official podcast Tuesdays, and stream Season 2 of Marvel Television's Daredevil Born Again on Disney Plus. Everything old is new again. Just ask Abercrombie. Motleyful money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motleyful analyst Jason Moser.

Jason, thanks for joining me. Hey, hey, thanks for having me. We've got a rundown on Peloton's woes and the story behind Abercrombie's latest resurgence. Jason, we're going to start with the fitness company. Peloton shares down 20% after the company reported its fiscal fourth quarter results. What drove the dive here? Well, I mean, it's a few things. It's certainly, feels like things are poised to get worse for the company before they get better.

And certainly, I think we all hope that they do eventually get better. It does feel like the overarching theme with this company right now is that management just doesn't have a firm grasp on the business yet. It's a business that's dealing with a lot of challenges all at once. But you got to do off the cap, right? They are trying. Right now, I'd say the stock, it's kind of a coin flip right now as to whether they're actually able to pull this off because even they admit there's no real North Star for modeling any

type of reliable outcome in regard to the business because there's so many variables in play right now. So I think there is just still a tremendous amount of uncertainty. We obviously know the past with this business, big challenges and recalls. I mean, ultimately a business that has had to make a tremendous pivot from what the initial value proposition was. So, yeah, They say turnarounds, rarely turn around. I mean, this is a turnaround, and we hope it does turn around. But I think right now the market is probably maybe taking the glass half empty view on this one. Let's take a little bit of a zoom in on some of those recall issues you mentioned.

When we saw the earnings results from the company, revenue down 5%. And there were a couple different factors there, I think. We saw, I think, some struggles in the hardware sales. We also saw, you know, this is a subscription business. And as there were issues with their products, I think they saw some people kind of move away from their subscriptions while they're waiting for their hardware to issues to get resolved, Jason. Do you feel like, as we look at this business going forward, they are out of the woods with this

product recall, or is this something that is going to continue to plague this business? I mean, we're definitely out of the woods, I don't think yet. I mean, it is something that, you know, this type of thing stays front and center for a lot of folks. It's interesting to see sort of the juxtaposition between recalls and. this line work and recalls in the automobile industry, right? Because recalls in the automobile industry are just, those are a dime a dozen, right? We seem all the time, chances are you've probably got two recalls outstanding on your vehicle right now, and you don't even know it. And that's just kind of the way that works. But with the business like this, it's obviously

very, very headline-centric. I mean, we've read these stories in regard to the seat post, for example. We know that they also had issues with their popular tread-prud. product. So, when you start talking about safety issues, unfortunately, when you bring the word death into certain situations like these, given the nature of why you're using these products to begin with and services, it really does make you kind of do a double take. So I think they are making the efforts to get past these recalls, but we're still in such the early stages of actually them getting past it. You don't really know if they're actually going to be going to be able to get past it yet or not. They're definitely getting positive responses,

at least from consumers, and wanting to go ahead and take advantage of these repairs. What remains to be seen is, will consumers going forward really trust this brand enough to continue buying that hardware along with any new innovations that they bring to the market in regard to that hardware? You mentioned some of the challenges that they've run through before, and you know, we pick one. I mean, there's the inventory issues. There's the recall we just talked about. There's, I think, some of the murkiness just around the market size for some of their products. I have noticed in recent quarters that this business has tried to make a little bit more of a pivot to their digital ambitions and moving away from the reliance on we need the hardware in a consumer's home in order to have a relationship with them.

Do you feel like there's traction there or something that we can be optimistic about in terms of that being a growth lever? I would say that for me really right now is one of the things I'm more optimistic about with this business. I mean, I like the hardware angle. I think that, you know, recalls notwithstanding, I mean, I think that they, generally speaking, make good hardware, right? They've missed a couple of, they've missed checking a couple of boxes along the way. But you're right. I mean, this is an investment in any business that has really kind of had to pivot away from

what it was known initially, right, as is this, the bike, right? The connected fitness that comes with it. And now we're seeing they're kind of trying to steer away from the hardware side because of these issues they've had worth their hardware. And if you look on, you look at their website now, for example, and see their offering in regard to their digital presence. They've got the Peloton app free offering, which is $0 per month. You've got the Peloton App 1, and then you've got the Peloton App Plus.

Peloton App 1, 1299 per month. Peloton app plus $24 per month. And then you can see that these offerings give you all sorts of different features and options. But one thing is, across all three, these, no equipment is needed, right? You don't actually need the Peloton equipment to be able to subscribe to these services. I think that's a great call, right? They don't necessarily have to be an equipment company. So to see them make this pivot and really start focusing on that subscriber side makes a big difference

to me, because as we know, I mean, we've seen some subscriptions. businesses all throughout our time here at the Fool covering all sorts of different companies. Subscription businesses can be very powerful. And to be clear, while product revenue was down 25% for the quarter, subscription revenue was up 10% for the quarter. So clearly, one of the few, unfortunately, right now, bright spots for this business. Yeah, and there's definitely a path there where they're able to appeal a little bit more to a more price-conscious customer or someone that just simply doesn't have the money on

hand to buy one of their more expensive hardware products, but still wants a fitness experience. I think there's something interesting there. It's just a little tough because we've seen some missteps before from this management team, and I wonder if they're capable of making that pivot happen. One of the things I wanted to zoom in on with this earnings release, Jason, was management expects cash flow to be negative for the next few quarters. But CEO, Barry McCarthy, said, I've never been more optimistic and excited about the future this business, stock is now at all-time lows. Do you feel like there's a reason to be interested

and excited about this company, or are you kind of waiting and seeing how this pivot and this resurgence may materialize? So, you know, I want to be optimistic. I mean, I know there's some challenges on the horizon, right? I mean, this is a seasonal business. And I mean, it was funny. They opened the shareholder letter with that very sentence. It's like it was a reminder. Please remember, this is a seasonal business. And if you look in the 10-K, I mean, they even, stated, so it's not something they're just trying to pawn off results. They say in the 10K, I mean, they've experienced higher revenue in the second and third quarters of their fiscal

year compared to the other quarters. Remember, this is the fourth fiscal quarter that they were reporting. So, in theory, we've got this holiday season coming up, and it is a seasonal business, so we should see some improvement there down the line. By the same token, again, kind of going back to that point I made earlier, that it doesn't, you know, this is Barry McCarthy's third call, with this company, right? He's still a relatively new CEO. And so you still, you want to give him a little bit of time to get sort of an understanding of the business and a grip on the drivers. But there's a question in the call, even, in regard to this uptick in sales over the last eight weeks, right? Someone, you know, someone asking, asking them, what was the cause of that?

And management literally said they didn't know. He didn't have an answer. He's like, I just don't know what to say. Maybe it was macro forces. Maybe it was something else. I mean, And even even, even, even fake it for me, all right? Tell me something. Yeah, give me some work with here. Positive response to the brand, because if you recall effort, something, right? So I feel like there's still maybe some work to be done on that side, messaging and advocating for the brand.

So maybe that could be seen as opportunity as well. I mean, this is clearly a business where the market is not giving it much credit at all. We've seen that happen before, and sometimes that can represent opportunities. I'm not calling this one a value opportunity, but I'm not calling it a value trap either. They're still making some interesting decisions here that lead me to believe that maybe there is a future where Peloton is a growing part of our lives. All right. From down 20 percent to up 20 percent, Abercrombie and Fitzshare is up big today.

After the clothing company reported beats on the top and bottom line with its second quarter results, Jason, huge jump post earnings from a company that I think people have been sleeping on a little bit. What's behind the pop? Well, yeah, I think we sleep on these companies a lot because we know fashion is so fickle, right? I think we've set on these shows for years and years. Fashion is just a notoriously difficult investment because it is fickle. And it's not something that is terribly lasting. I think in this case, you've got the one-two punch of outperformance along with raising guidance.

In the market clearly loves that. But what's really interesting to note here, you go all the way back to 2019. The top line for this company hasn't really buzzed. That income's cut in half. Now you've got the stock trading at 25 times full year estimates. It's like the market is really excited about Abercrombie and Fitchigan. But I do understand at least the optimism there in a retail environment right now, where we've seen a lot with results from companies like Target, where there are a lot of consumer headwinds. We're talking about shrink and organized crime and theft, inventory issues.

And Abercrombie's not really having to deal with that as much. I mean, it's seeing a little bit more positive momentum, I think, partly because maybe it's a little bit more of an understood customer base as opposed to something like a target that is a bit more of a broad customer base in what they have to offer. So, listen, I mean, Abercrombie and Fitch, they've had their fair share of difficult years. So it's nice to see them sort of turning the tables here a little bit and enjoying some success. Yeah, you mentioned the financial picture, and what's kind of interesting is we mentioned shares up 20% on the earnings news.

They're up 110% year-to-date, way ahead of the S&P's return, way ahead of what we're seeing from other retailers for American Eagle, Gap, Urban Outfitters. So this company is clearly doing something right. What I think is kind of interesting, Jason, is just anecdotally, their merchandising mix looks quite a bit different than maybe your older cousins, Abercrombian Fitch, from the early aughts and 90s. And I've seen it firsthand because in my household, I had not really been thinking much about Akrami and Fitch just last week. My girlfriend had a package come from them. And I was looking at what came in the mail, five plaintiffs. She said they're her favorite plaintiffs. And you

look at their website, similar to what we were talking about with Peloton, actually looking at what they're offering here, it's a lot of stuff that looks a lot more like Madewell. And some of those retailers that are a little bit slimmer, a little bit more basic in terms of what they're offering, it's a big departure from what we've traditionally seen from this retailer. Yeah. Well, sometimes less is more. I think maybe we've hit that stage in fashion where, I mean, there was a time where

logos were more and more in vogue, and that was something that consumers appreciated more. And maybe now understated is a little bit more of the way to go. I think, I'd be talking about returns. I mean, you look at the three-year chart for this thing. The stock is up 405 percent over the low. last three years. I'm just, I'm really, I'm just astounded by that. I mean, but hey, hats off to them. That's tremendous performance. And I think, you know, you look at what, I think you're right. I mean, you go back to sort of this idea. They're no longer, this,

it's not this Abercromb being fitch that we knew from years ago, right? It's, they consider themselves and take this, take this for better or for worse. They consider themselves a lifestyle brand now, Dylan. And we know that comes with some, with some caveats there. So sometimes you see companies kind of leaning into that lifestyle brand at the peak of their success. I'm not calling this the top, but I'm just saying they threw the lifestyle thing out there. So let's keep that in mind. But I do appreciate the idea here, though, in that when you look at the business itself, they had the Abercrombie and Fitch brand along with the Hollister side of the business.

And Hollister, which is a bit more attractive to younger demographic teenagers, so you've kind of got that back-to-school demo there. and then you've got the Abercrombie and Fitch Brand, which, you know, leans to a little bit more of an older demographic. But these two sides of the business play off of each other very well, right? You've got Abercrombie, which historically presents a higher operating margin business, but favors a more digital consumer. And then you've got Hollister, which is a lower operating margin business,

because it favors a bit more of an in-store experience. I think that comes with that younger demographic that's actually looking to just get out there and go through the stores and whatnot. About two-thirds of Hollister's business is still in store. So I think one thing this company is doing really well, and it kind of goes to that Omni-channel experience that we talk about with so many retailers that are witnessing successes, that they are meeting their customers where their customers want to be met, right? Whether it's that Hollister demographic or that Abercrombie and Fitch demographic, they're doing it all.

And I think that makes a big difference of certainly presenting itself in the numbers. Yeah, and I think we've seen some comments from management in the quarter talking about how they're really focusing on customers having clothing that they can wear in the workplace and also outside of the workplace. That kind of transitional outfit that works for nightlife and the 9 to 5, and it seems to be connecting with the customer base. I think you hit on something there that I was thinking about this and putting together some notes for today. They really are benefiting from this notion that we've got sort of a different view on the way we work right now. I mean, some of it's all remote, some of it's back into the office, some of its hybrid, but it's not the way it was before. And so fashion is extending itself right into more situations.

And certainly Abercrombie is benefiting from that. And I think they're also benefiting from what we've seen here, at least, with a number of retailers. I mean, when you just get back down to the numbers of it all, I mean, the market's clearly excited about the fact that the company's inventory levels are down 30 percent from a year ago. The impressive part is, with those inventory numbers down that much, 30 percent, we saw gross margin tick up 460 basis points, based on strong store performance, lower freight cost, and it was offset a little bit by some higher input costs on the cotton side. But ultimately, you saw operating margin 9.6 percent up considerably from a year ago, where

essentially they were just break-even. So, I mean, all things considered, not only are they meeting their customers where they want to be met. you can see that materializing and manifesting into real concrete numbers in the business. Listen, it's not a stock that I would be jumping on today at 25 times full of your estimates, but I certainly understand the market's enthusiasm. Yeah, you beat me too, Jason. I was going to ask.

I mean, this is a business that I now, I think, is trading an earnings multiple that may surprise some people. We talked about the one-year look and the three-year look, but this is a business that is also highly cyclical. And we have seen this story before, where it seems like they catch lightning in a bottle, and then we wind up looking at the longer picture and saying, you know, they actually haven't returned a ton of value to shareholders short term or even over one to three to five year, depending on the look and your cost basis.

Is this a business or an industry in general that you're interested in, or you just feel like it's too hard to follow the trends here? So I certainly cannot. I do not profess to be on top of the fashion trends, that's for sure. But, you know, this just generally speaking, it's not a market that really, really, it's not one that I look to first, because it's a difficult one for me to really embrace the sort of that buy-to-hold mentality. It's not where I feel like I could buy and plan on owning for years on end and hopefully adding to as time goes on. I think it's a little bit more suitable to your value investment, right? I mean, for value investors looking to find

impaired businesses that offer a proposition where there might be a short-term catalyst or a long-term trend in play, I mean, it reminds me many, many years ago here when I, I I did that sort of thing with Gap, right? I found Gap at the time. It was really suffering because of a number of self-inflicted issues, along with some macro forces that were hurting the business. I jumped in there with sort of that value thesis. I didn't get in quite at the bottom.

I didn't sell quite at the top, but it was a rewarding investment, and I enjoyed it. But man, I remember afterwards feeling like, damn, that was a lot harder than I feel like it had to be. It requires a lot of work. It requires a lot of attention. It absolutely can be done. But I think it probably fits more in that value style of investing as opposed to that buy-to-hold investing. So just depending on what your flavor is there, take that in consideration. Jason, always happy to have your investing advice. I'll ask other people about the fashion advice. We're two men in T-shirts recording this podcast. Thanks so much for joining me for today's show.

Thank you. As always, people on the program may own stocks mentioned, and the Motley Fool may have. have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.