Mounting Foreign Exchange Pressure, Outdated Business Models Puts These 2 Retailers At Risk

Christian Buss of Credit Suisse on Friday commented in a note that deflationary pressure in the U.S. apparel market and mounting foreign exchange headwinds puts in to question a potential earnings turnaround for both Gap Inc (NYSE: GPS) and Abercrombie & Fitch Co. (NYSE: ANF) in 2015.

According to Buss, the historical "High-Low" pricing model that Gap stores and Abercrombie brands still rely on has "lost relevance" with consumers who seek better value at retailers like UNIQLO, H&M, Zara and Forever 21.

The analyst added that his tracking of pricing and markdown data shows "persistent" deflationary pressure and that the outlook for top-line growth in the apparel sector is "limited" for apparel brands that aren't at the forefront of the pricing curve.

Buss also noted that with significant international exposure for both Abercrombie & Fitch (35 percent) and The Gap (22 percent) and currency movements "deeply unfavorable" over the past three months, the risk of downward revisions to international earnings is elevated.

Finally, Buss explained that Primark's entry in to the U.S. with up to 10 stores by the end of 2016 will prove to be disruptive for the apparel sector as a whole. The Irish-based retailer's low pricing strategy will help "reset" consumer expectations for pricing and take market share away from mid-value specialty retailers, department stores and discounters.

Shares of Abercrombie & Fitch were downgraded to Underperform from Neutral with a price target lowered to $21 from a previous $25.

Shares of The Gap were downgraded to Underperform from Neutral with a price target lowered to $37 from a previous $40.