American Eagle Outfitters (AEO) recently posted record results for Q4 fiscal 2012 driven by strong brand recognition, better inventory control and fewer markdowns. Revenues and comparable store sales increased by 9% and 4% respectively.
However, the retailer lowered the outlook for Q1 fiscal 2013 due to weak consumer spending resulting from the payroll tax increase and unfavorable weather conditions. This is the main reason shares were under pressure on Wednesday. Nevertheless, we believe the fundamentals remain strong and that AE’s rewards program, strategic store expansion and emphasis on inventory control should aid American Eagle Outfitters’ future growth. Additionally, the retailer is also looking to revamp its infrastructure to improve efficiency.
Brief Review of Fiscal 2012 Performance
Comparable store sales for the fiscal year increased by 9% due to the company’s brand strength and a good response to fashion changes. However, this growth slowed in the fourth quarter (4%) as the U.S. witnessed its worst holiday season since the recession. For the entire fiscal year, inventory control, newness in styles, colors, fits, washes and a balanced pricing strategy allowed the retailer to operate with fewer promotional activities. These factors along with the decline in cotton prices helped American Eagle improve its gross margins by 330 basis points in fiscal 2012.
A Promising Future Awaits
American Eagle Outfitters’ shares slumped by 10% as it reported weak traffic in February due to the payroll tax increase and unfavorable weather conditions. However, the retailer’s healthy brand recognition, rapidly growing direct-to-consumer business and improving store productivity through consolidation are likely to drive future growth. In addition, we expect the following strategies to help:
American Eagle Rewards Program: After registering for the program, customers are offered one reward point per dollar spent at the stores or e-commerce website. At the end of every three months, the points are totaled and customers become eligible for discounts. For instance 100 points equal 15% discounts and 200 points equal 20%. Additionally, customers are offered 15% discounts on purchases made during their birthday months. Last year, the retailer witnessed a 36% increase in new customer signups for the program, and we expect this program to help drive traffic in the future.
Inventory Control: One of the reasons why American Eagle Outfitters was able to launch new fashion and operate with fewer discounts was its control over the inventory. The retailer reduced the total merchandise inventory at the end of Q4 fiscal 2012 by 10%. American Eagle Outfitters has stated that it is looking to reduce lead times by a few weeks to a few months. This should make it more responsive to changing fashion and customer needs and maintain tighter inventory. Going forward, this will help the retailer’s comparable store sales growth.
Revamping Infrastructure: American Eagle Outfitters is investing in infrastructure to support its operations. The retailer will be implementing a new global enterprise system, which will integrate its point-of-sale system and merchandise system. It is doing so to serve its customers better and create a platform for global omni-channel capabilities. Moreover, the company is also building a new distribution center to support its rapidly growing e-commerce business. The management expects these initiatives to start yielding visible results by 2014.
Strategic Expansion: Although American Eagle Outfitters is consolidating its store network in the U.S., it is opening some new stores in underserved locations. In 2012, the retailer closed down 41 stores but opened 14 new stores in the U.S. It is looking to expand in key markets such as Miami and New York where its presence is weak. This is likely to have a positive impact on its store productivity. Also, the company is scaling its expansion in international markets where it can generate more revenue per square foot. It recently opened its first franchisee store in the Philippines and will assume control of its licensee stores in China. The retailer plans to continue expanding in these regions throughout the year. Furthermore, American Eagle Outfitters has plans of opening about six stores in Mexico in 2013 and many more in the coming years. This positions the retailer well for future growth.
Our price estimate for American Eagle Outfitters stands at $25, implying a premium of about 20% to the market price.
Disclosure: No positions.