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Despite announcing in-line 4Q12 results, hiking its dividends and announcing a new share repurchase program, American Eagle Outfitters Inc. (AEO) stock fell 11% and is currently trading at $20.27. There were two reasons for the fall in stock price : 1) 4Q12 Comparable Same Store Sales (SSS) came in at 4% (due to slow mall traffic) lower than its January SSS of 5% (due to strong holiday season) and 2) less-than stellar 1Q13 EPS outlook of 16 to 19 cents (vs. analysts' expectations of 25 cents per share). With macroeconomic headwinds and unfavorable weather affecting consumer spending in February, American Eagle guided for this negative mid single-digit SSS (vs. 17% in 1Q12).


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Sales and SSS


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American Eagle Outfitters is a specialty retailer that operates in the U.S. and Canada, and online. In May 2012, the Company announced that it would exit its children's business, 77kids, which includes 22 stores and the online business. In August 2012, it completed the sale and incurred after-tax losses of $32 million, or $0.16 per share.

When majority of the retailers were expanding internationally, mainly in China, American Eagle opened its first international store in Dubai. The company still has a relatively low international store count with only 69 of its 1,255 stores being international.

Further, in early 2012, it realized that the company was operating underperforming stores and investing more cash than required. Right now, American Eagle is in the middle of its turnaround plan (on a pruning spree, closing underperforming stores and diverting resources into its online presence) with 2012 being a roaring success. Its FY12 operating margin of 12.6% was the best since 2008.

Strong 4Q12 results:

  • 4Q12 revenues increased 11% with total SSS, including e-commerce of +4%. By business, American Eagle Outfitters SSS increased 1%; Aerie stand-alone store comps declined 3% (as it streamlined its assortments to focus and shift to online) and e-commerce increased 24%.
  • 4Q12 Gross margin increased 600 bps to 41.2%, led by a 390bps improvement in IMU (initial mark-up) due to lower cotton costs and other product cost benefits, 190bps through lower markdowns and 20bps through rent leveraged.
  • Selling, general and administrative expense increased 21% to $253 million and de leveraged 230 basis points. This was mainly due to higher incentive costs and advertising investment.
  • Total merchandise inventories fell 10 percent to $332 million as the company decided to focus on lesser promotions and reduced markdowns. Further, its inventory at cost per foot was down 8%.

Four strategies:

  • Fortify: For FY13, American Eagle is focused on strengthening its brands, driving profitability in North America and then setting the stage for international expansion. As per the Management, it will make critical investments to develop its infrastructure (including new point of sale system and merchandise planning tool). FY13 capital expenditure plan is between $250 to $280 million (vs. FY12 capital expenditure of $93 million) focused on growing its direct business, new point-of-sale system and new merchandise planning tool.
  • Growth: It will accelerate growth across North America and strengthen its channel performance. It plans to open 7 to 10 new mainline stores in the U.S. and Canada, 50 or more store remodels, 40 new factory stores and 6 new stores in Mexico (where it received strong initial response).With respect to its fleet review and repositioning, it plans to close 40 unproductive stores as it focuses on rebalancing its store into more productive and higher margin channels.
  • Transform: It plans to focus on maintaining strong growth in its direct channel and building an omni-channel capability.
  • Return: It will continue to build its capabilities and drive high-performance across its brands with the target of 7% to 9% top line CAGR, 12% to 15% EBIT CAGR and ROIC of 14% to 17%.

Conclusion:

  • American Eagle's near-term focus is driving a competitive top line, generating margin flow-through from improved inventory management, rebalancing its store fleet, investing in its online business and gaining leverage on infrastructure. And once these have been established, only then, will it think of expanding internationally.
  • American Eagle is on the same plane with its main competitor, Gap Inc (GPS). Both the companies are in the middle of a turnaround and have seen positive sales growth and SSS. Both are focusing on their core brands, improving quality and cutting its shipping time.
  • On the other hand, its other competitor Aeropostale, Inc. (ARO) has been facing plummeting sales and SSS and the company has not been able to focus on its strength. In its recent earnings call, the management admitted that all it could do right now "is to chase fashion and increase its overall speed in the market".
  • In FY15, American Eagle's focus is going to be on its strength - its brands, U.S. stores and online. In FY14 international growth and omni-channel will begin to play a larger role. However, the key area of focus will be the company's core turnaround.
  • With similar PE (Gap: 11.86 AEO: 11.80), American Eagle isn't a bad choice. Its recent pullback might well be a good time to invest.
Source: Tepid 1Q Outlook Leads To 11% Drop In American Eagle Outfitters