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More store closures may be ahead for Abercrombie & Fitch

Pedestrians stand outside of the Abercrombie & Fitch Co. store on 5th Avenue in New York, U.S., on Sunday, Feb. 28, 2016.
Michael Nagle | Bloomberg | Getty Images
Pedestrians stand outside of the Abercrombie & Fitch Co. store on 5th Avenue in New York, U.S., on Sunday, Feb. 28, 2016.

Abercrombie & Fitch's store fleet may be getting another haircut.

Roughly 50 percent of the retailer's 745 U.S. leases are up for renewal over the next 18 months, the company said Friday. With profits under pressure, this window gives management the opportunity to continue pruning the company's footprint without being penalized for exiting space early.

Though management did not outline how many of its domestic stores could potentially close, it plans to shutter 35 locations in the fourth quarter through natural lease expirations. That's in addition to the 15 stores it's closed so far this year.

"I would not be surprised if half of those [locations up for renewal] end up closing," Garrick Brown, Cushman & Wakefield's vice president of retail research for the Americas, told CNBC.

Between the Abercrombie & Fitch and Hollister brands, the company has shuttered more than 350 stores over the last six years.

Retailers across the industry have been taking a closer look at their store fleets, as consumers shift more of their spending online and mall traffic declines. Their troubles stem from a combination of having stores in poor locations, and from internal miscues, said Neil Saunders, CEO of Conlumino research firm.

That, in many cases, has resulted in a continued slide in comparable-store sales metrics, even as weaker locations are removed from the calculation. In addition to Abercrombie, Macy's and Gap are in the midst of trimming their store counts to boost profitability.

"They're under a lot of pressure to do so," Brown said.

Indeed, announcements of massive store closures are typically met with approval by Wall Street, as they allow retailers to cut costs and free up cash. Yet exiting stores is never an easy decision — nor is it always the right one.

In some cases, the space that struggling retailers occupy is located in prime shopping centers. When those leases come up for renewal, landlords can try to squeeze them out of the space for a more productive tenant, by hiking the rent more than 25 percent, Brown said.

If such a rent hike tips a store into unprofitable territory, the retailer may be exiting one of their better-performing stores, Brown explained. Generally speaking, Abercrombie's stores are in good locations, he said.

"The class A landlords know that these retailers are kind of in a vice," Brown said. "The Street wants them to close in specific locations, and the places where the Street wants them to stay open, those landlords know it."

Some retailers are trying to work around this challenge by identifying space in up-and-coming markets or centers, or ones that are going through a turnaround. In other cases, they'll come to an agreement with a landlord to forfeit prime space in one center, and in exchange, get favorable terms in another. They will also sign shorter leases to give both parties flexibility.

It's important that retailers maintain a physical store presence, as it also helps their digital sales. When retailers exit a certain location, they often see a corresponding dip in that area's online revenue. That's because shoppers enjoy the flexibility of returning items to the store, and because physical space keeps a brand top of mind. At Abercrombie, the sales retention rate when a store closes is less than 20 percent in total, the company said.

"You do have to be quite sensitive about this," Saunders said.

That said, for many retailers, closing stores is a necessary part of bringing supply and demand back into equilibrium, and boosting their margins in the process.

In addition to closing stores, Abercrombie's management is tweaking its existing fleet. It will complete 64 remodels for its Hollister label this year, and will test a new Abercrombie prototype store in early 2017.

Abercrombie's turnaround veered farther off the rails Friday, when comparable sales at its namesake brand doubled their decline from the prior quarter. That label is trying to reinvent itself as a more upscale, mature line, and is moving away from its exclusionary reputation.

While it faces a number of challenges, it benefits from the fact that so many of its leases are coming up for renewal, Brown said. That means it shouldn't have to take unnecessary store closing charges to appease investors. The company also has the benefit of a solid balance sheet.

"It continues to maintain a conservative financial policy, with moderate debt and leverage levels and very good liquidity, Moody's analyst Mike Zuccaro told investors. "Balance sheet cash continues to amply exceed funded debt levels. We expect this to remain the case as the company further implements its turnaround strategy."