Would a Breakup Save Abercrombie?

Shares are getting punished Friday after the apparel retailer said that the weak economy’s drag on retail sales likely would create a loss in its first quarter. The fiscal guidance of $3.35 to $3.45 under the cost method of accounting for inventory does not make the company expensive. The problem is that the growth rates are not driving interest. The question to ponder here is whether this company should break apart its brands to unlock value.

While Abercrombie & Fitch has worked to modify its inventories and selections, it is also closing stores that are underperforming. Simultaneously, it is expanding overseas. It said:

In Fiscal 2013, the Company expects to open Abercrombie & Fitch flagship locations in Seoul and Shanghai, as well as approximately 20 international Hollister stores throughout the year. The Company expects to close approximately 40-50 stores in the U.S. during 2013, primarily through natural lease expirations.

The move sounds a lot like where Gap Inc. (NYSE: GPS) found itself before that ship turned around. It was suggested that Gap break up that trifecta of brands many times, and now with Athleta it has four big brands. So the breakup never came. Would a breakup heal Abercrombie? Maybe, but that comes with a huge risk for shareholders in that the brand strength in one area cannot offer cover for a weaker brand under the same management.

An accounting change adjustment may be partially confusing and partially a help at the same time. Now the company will no cut the value of its inventory unless it expects to discount that inventory. What about the higher dividend? That has not helped shares even though it went up to $0.20 from $0.175 per share per quarter. This just is not enough to move the needle.

So how would a breakup of Abercrombie & Fitch really work? For starters, the Abercrombie & Fitch stores would not be able to dump the ties to Abercrombie Kids. But what about Hollister, and what about the undies brand of Gilly Hicks?

The company has 266 Abercrombie & Fitch stores in the United States and 19 internationally. The Abercrombie Kids has 144 U.S. stores and six internationally. There are some 482 Hollister stores in the U.S. and 107 internationally. Gilly Hicks has only 20 stores in the U.S. and seven stores internationally.

After a 6.6% drop to $45.80, against a 52-week range of $28.64 to $54.10, A&F has a market cap of $3.6 billion. This would be far easier to breakup than what Gap would have had to do with Gap, Banana Republic and Old Navy. Gap went the other way and has caught a great ride with its Athleta expansion to compete with Lululemon Athletica Inc. (NASDAQ: LULU).

Will A&F get to the point that it wants to break itself up to unlock value, or will it decide to expand on whatever it sees as the next generational change in apparel? That remains to be seen. Keep in mind that the $45 or so stock price today compares to a share price peak above $80 before the recession and above $70 as recently as 2011.