Mike Mathias, Retail CFO of American Eagle Plot Post-Pandemic Strategy

Abercrombie & Fitch wishes to reduce promotional activity in order to increase profitability.

Abercrombie & Fitch wishes to reduce promotional activity in order to increase profitability.

Apparel chains look to reduce inventory, rents, and promotions in order to focus on profit growth.

Finance executives at apparel retailers are attempting to increase profitability by reducing inventory levels, lowering rent payments, and relying less on promotions.

Clothing chains such as American Eagle Outfitters Inc. and Abercrombie & Fitch Co. are rethinking their business models following a year in which many of their locations were temporarily closed due to the coronavirus pandemic. Online sales as a percentage of revenue continue to grow, reducing the need to maintain the same level of inventory and operate the same number of stores as prior to the pandemic.

“We discovered we can run this business on less,” said Scott Lipesky, chief financial officer of Abercrombie in New Albany, Ohio. “You have significantly higher margins,” he explained, adding that Abercrombie wishes to continue operating with less inventory.

As of May 1, the company reported inventory of $389 million, a decrease of 9% from a year ago. Abercrombie earned $57 million in operating income for the quarter, compared to a loss of $209 million in the prior-year period.

AEO, which owns the American Eagle and Aerie brands, is also looking to reduce its clothing inventory, including through portfolio pruning, finance chief Mike Mathias said. “Bottoms and jeans continue to offer significant inventory benefits,” Mr. Mathias explained. The company reduced the number of tops it sold at American Eagle last year. Additionally, AEO said it is ordering smaller quantities of clothing from its global suppliers.

Smaller orders from suppliers help retailers run fewer promotions to sell their products. “We want people to buy things when they see them, rather than waiting for a sale,” said Mr. Lipesky of Abercrombie. According to the CFO, the company has had fewer promotions over the last three quarters. “With less inventory, you can do that,” he explained.

American Eagle Outfitters’ Chief Financial Officer, Mike Mathias.

According to Hackett Group Inc., a consulting firm that reviewed the 1,000 largest nonfinancial U.S. companies by revenue, general and specialty retailers held an average of 69 days of inventory outstanding in 2020, down from 72 in 2019. Retailers on the internet and catalogs had an average of 39 days of inventory outstanding last year, compared to 48 in 2019, Hackett said.

“Essentially, the pandemic forced retailers to recognize the value of selling less but charging more,” said Simeon Siegel, managing director at financial services firm BMO Capital Markets. Nonetheless, continuing to do so as the economy recovers will almost certainly prove difficult. “Maintaining the promotional line and watching customers exit is a significant strategic challenge,” he explained.

Closing locations and negotiating lower rents can also help apparel companies boost profits. AEO closed 57 stores last year and signed nearly 200 short-term leases, providing the company with additional flexibility as it seeks to reduce the number of American Eagle locations, Mr. Mathias explained. Mr. Mathias said the brand had approximately 850 locations in the United States and Canada at the end of 2020 and aims to reduce that number to between 600 and 700 by 2023.

AEO, which is expanding its Aerie brand, currently has 450 leases that will expire at the end of the year, he said. The company saved $7 million in rent in its first fiscal quarter ended May 1, compared to the same period in 2019, which the company said it uses as a pre-pandemic baseline. AEO reported a quarterly operating income of $133 million, up from $48 million in the first quarter of 2019.

Abercrombie has approximately 250 leases that will expire at the end of 2021. “If we can’t get that deal, we’re out,” Mr. Lipesky said, referring to landlord negotiations. The company, which generates roughly half of its revenue online, shuttered 137 locations in its most recent fiscal year as leases expired. Abercrombie began closing locations earlier than some of its competitors following a decade of overexpansion, analysts said. “There are still some stores that are too large,” Mr. Lipesky explained.

Hennes & Mauritz AB, a Swedish clothing retailer, also saved money by negotiating with landlords during the last quarter. “We get better terms on rents,” the company’s CFO Adam Karlsson stated in a transcript at the end of March.

Gap Inc., the parent company of the Gap brand as well as Old Navy, Banana Republic, and other labels, announced last week that it closed 99 stores and opened 74, bringing the total to 3,571.

However, it remains to be seen whether costs will continue to rise, as online sales require investment in distribution centers, transportation, and labor to fulfill orders. According to AEO, some of the savings generated by lower rents in the company’s first fiscal quarter were offset by higher logistics and supply chain costs.

“To succeed online, you need a healthy gross profit margin,” Jay Sole, an executive director at UBS Group AG, explained, citing recent increases in freight costs and wage pressures.

Mr. Mathias stated that AEO is currently evaluating whether to add a fourth hub to its roster of owned distribution centers. “We want to be more accessible to our customers,” he explained.

Congested supply chains create additional challenges, particularly when operating with lower inventory levels, according to Janine Stichter, an analyst at financial services firm Jefferies Financial Group Inc.

“There are bottlenecks at every step, and consumer demand is less predictable,” Ms. Stichter explained. “Executives are attempting to determine the best course of action.”

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