American Eagle Outfitters Should Post Strong Results

Feb.28.13 | About: American Eagle (AEO)

As American Eagle Outfitters (NYSE:AEO) comes out with its Q4 fiscal 2012 earnings on March 6, we expect good results backed by the retailer's U.S. store consolidation, a good response to its product assortments and a balanced pricing strategy. Looking at the trends in the online apparel industry, we expect substantial growth in American Eagle Outfitters' direct-to-consumer business as well. Furthermore, lower cotton prices might help the retailer's overall margins for 2012. However, a low proportion of fashion focused products and a weak holiday season in the U.S. could have a mitigating effect.

Store Consolidation Will Help the Retailer's Store Productivity and Margins

American Eagle Outfitters reduced its store count to 920 by the end of 2011, from 946 in 2009, as it closed down its underperforming stores. With this consolidation, the retailer intends to improve its store productivity. For example, the retailer operated 934 stores in 2010 with an average revenue per square feet of around $440. Whereas in 2011, the store count came down to 920 and the revenue per square feet increased to about $470, with an overall revenue increase of 1.4%. American Eagle Outfitters also closed down 11 stores by the end of Q3 fiscal 2012, and we expect the store count to be around 905 at the end of the fiscal year.

With the increased store efficiency, American Eagle Outfitters' margins might see a slight positive impact. This will be further complemented by lower cotton prices. Cotton prices were at a peak in 2011 ($2.29/pound in March 2011), which resulted in a sharp decline in American Eagle Outfitters' EBITDA margins. However, cotton prices have been coming down since then ($0.83/pound currently) and should help the overall margins for fiscal 2012. Abercrombie & Fitch (NYSE:ANF) and Gap (NYSE:GPS) are also following the same tactics by closing their underperforming stores in the U.S. The American Eagle stores constitute about 65% of the company's value, according to our estimates.

Direct-to-Consumer Growth Is Likely to Continue Its Pace, Driven by Industry Trends

The apparel industry on the whole is showing signs of improvement with major players such as Gap, Urban Outfitters (NASDAQ:URBN), and Abercrombie & Fitch reporting significant growth in their direct-to-consumer business. Gap and Urban Outfitters reported direct-to-consumer revenue growth of 23% and 36%, respectively, in their previous quarterly results. Aeropostale's (NYSE:ARO) growth has been slower than the overall apparel industry's growth, but it reported a substantial increase in its direct-to-consumer revenues during its last quarter earnings announcement.

On average, revenues from American Eagle Outfitters' direct-to-consumer segment have increased by about 10% annually during 2009-11. However, with the ongoing shift in the apparel industry, the growth rate picked up in 2012. The retailer's direct-to-consumer revenues increased by 26% in the first nine months of fiscal 2012, and we expect similar results for the entire year. The direct-to-consumer segment constitutes 25% of the company's value according to our estimates.

Fashion Newness and Marketing Should Help

American Eagle Outfitters has witnessed strong customer response to its fashion products in both its men's and women's businesses. The retailer added new styles, fits, colors, washes, prints, patterns, and treatments to its apparel range. It also maintained the strength in its core denims and bottoms by adding the prevailing fashion trends to them. Moreover, shorts, knit tops, and dresses have performed well. Due to this, American Eagle Outfitters' comparable-store sales increased by 17%, 7%, and 8%, respectively, in the first three quarters of fiscal 2012. This shows that American Eagle Outfitters enjoys strong brand recognition among teens, and its fashion trends are being welcomed by its customers.

In addition to staying attuned with the fashion trends, American Eagle Outfitters is following a 360-degree integrated marketing plan, including TV commercials and advertisements on mobile phones. The retailer has advertised through a number of social media partners as well. Amid the highly promotional U.S. teen apparel industry, the retailer is looking to add more product variety in the mid-priced and opening priced tiers.

The current teen apparel market is highly sensitive to changing fashion trends. While American Eagle Outfitters has been quite responsive in this aspect, its fashion products only account for 25% and 15% of women's and men's apparel, respectively. The remainder of the portion includes the core basics and core fashion. Although these categories have performed well due to American Eagle Outfitters' brand appeal, the retailer may have to increase its fashion offerings over the longer run. The lack of fashion focused apparel has severely impacted the relatively less popular brands, such as Aeropostale.

Our price estimate for American Eagle Outfitters stands at $25, implying a premium of about 10% to the current market price.

Disclosure: No positions.