American Eagle Should Consider A Change In Strategy

| About: American Eagle (AEO)


American Eagle's current strategy ignores the big picture opportunity it has to be the timeless, All-American brand with universal appeal.

American Eagle has a nice dividend track record and strong balance sheet that should leave investors comfortable in terms of risk-reward.

Investors should involve themselves in discussions of the company's strategy, positioning, and future.

Over the last month or so, readers of my Dividend Focus newsletter have been aware of my opinion that American Eagle Outfitters (NYSE:AEO) has moved into value territory that I consider to be attractive. In my free 24 page report on AEO stock, I cite a very nice 10 year dividend track record, a strong balance sheet, and a brand and image that is built around a timeless concept.

The balance sheet should not be mentioned without clarification that while AEO carries no debt, they do carry large operating lease obligations, $1.755 billion worth, to be exact. Operating leases are not the same as debt. At least some of the leases carry early termination options. Further, leases can be renegotiated without triggering a default that leaves the stock worthless. So they are not the same as debt, but they cannot be ignored either. I go into more detail about this in my report.

As far as the dividend track record, American Eagle is not a company that increases their dividend each year, or even every other year. If you're trying to build a highly predictable stream of dividend cash flow that includes annual growth, this may not be the stock for you. Further, American Eagle operates in a fickle consumer industry, and does not have a rock-solid 115 year dividend track record like consumer staple company General Mills (NYSE:GIS), for example.

However, they have shown a commitment to rewarding shareholders with increasing cash payments since 2004, when a quarterly dividend was instituted at $.02 per share (split adjusted). The most recent quarterly dividend was $.125 per share, representing a growth rate of more than 20% annually over the last 9.5 years. Further, in the midst of a great 2012, the company paid out a special $1.50 dividend in addition to all of its regular quarterly dividends of $.11 each. If that weren't enough, the company has also paid out its quarterly dividends early at times when it was sitting on excess cash. This kind of history tells me that the company culture includes being serious about rewarding shareholders with cash. The powers that be at AEO may not concern themselves so much with making sure the dividend is a penny higher every year or every other year, but so far at least, the company has more than made up for that with special dividend payments and strong overall dividend growth.

Now for the main point of this article, which is that American Eagle's brand is built around a timeless concept. Obviously we all immediately understand the phrase "American Eagle" to evoke freedom. In terms of fashion, the phrase should also conjure up the image of the classic, All-American guy or girl. Many readers might be unaware that American Eagle began as an outdoors themed clothing store. The history available through internet research is spotty, but there appears to have been a somewhat rugged image that appealed primarily to men. At some point along the way, the brand became less about a timeless concept and image, and more about the latest trendy fashions for teens. So as I noted in my report, my concern is that they are giving up some of the inherent value in their brand by ignoring these timeless concepts, and instead promoting some way out trends.

Going a little further with this idea, I think the company's leaders should consider changing their strategy somewhat to capitalize on the timeless concept. Right now, they are operating solely in the teen fashion space. Everyone who follows this industry is aware of the issues they face: a fickle, often cash strapped customer base, low barriers to entry, lots of competitors, shifting consumer trends, declining mall traffic, etc.

I think there is a good solution to all of these problems. Stop being a teen retailer. I don't mean to say that AEO should stop marketing to teens, just that they should stop trying to market exclusively to teens. Polo by Ralph Lauren (NYSE:RL) is a great example of a brand built around a timeless, classic, All-American image. Teens buy Ralph Lauren clothes, but so does everyone else. They have clothing products that run the gamut from infant's clothing to expensive suits. They don't stop at clothing either. They sell towels, luggage, bedding, curtains, you name it.

As with all brands, the popularity of Ralph Lauren's brands fluctuates somewhat with consumer tastes. But year in, year out, it's clear that the classic All-American brand enjoys a sustainable competitive advantage. The high historical returns with relatively low volatility of RL stock reflect that advantage. While it won't happen overnight, I don't see any reason why American Eagle can't implement a similar positioning and strategy for their brand.

Why do I think this is a good idea? There are several reasons:

  1. American Eagle, currently, is still trying to be a top teen and young adult brand. However, many young people are moving away from what they see as cookie cutter brands. In other words, for these people, there is no such thing as a cool brand. There are only cool clothes that they think expresses their individuality. AE has been trying to sell young people on the idea that their clothes are about expressing individuality, but the super trendy, ultra fashion-conscious types aren't buying it. They are instead flocking to fast fashion retailers. Fast fashion retailers seem to be doing a better job of capturing the latest trendy fashions, getting them in stores faster, and doing so at better perceived value. Plus they don't have their brand name plastered in giant stenciled letters across the clothing. Why try to copy or compete with these retailers when you don't have to?
  2. There are teens that are not super trendy, and ultra fashion-conscious, but that instead like the timeless, All-American concept. There are teens and young adults who don't want to be associated with the latest gaudy trends. There always will be such shoppers among the teen and young adult demographic. They buy clothes too. Further, classic looks are classic for a reason: they always look good. There are plenty of young people who go for classic looks. American Eagle still has great classic looks in their stores. But some shoppers may be unaware of this. I fear that some of them might be feeling alienated from American Eagle's brand when they walk by the store and see a 10 foot poster of a guy wearing a super tight pink shirt on top of his camouflage shorts. AEO shoppers used to see classic styles set against a backdrop of mountains and streams. If they walk in today, they're likely to see 80s-inspired skater styles set amidst a concrete jungle. The shoppers who like the more basic, rugged, outdoors inspired image may not even be walking into the store once they see the new trends American Eagle is pushing. I could be wrong. But I think American Eagle could decide to accept a role as the classic, All-American niche player in the teen market, and seek growth by opening up their brand to other consumer age groups, which leads me to my next point.
  3. I just came back from a trip to a popular beach town. While there, I noticed thirty-something men wearing American Eagle shirts. I wondered if this was part of a larger trend. There is a very large Tanger Outlet (NYSE:SKT) nearby with an American Eagle factory store, so I decided to go check it out. It may have been just the time of year, but there was not a single teenager in the store. Just a bunch of old dudes like me. So, it's possible that significant numbers of thirty-something adults are already buying American Eagle clothes, at least some of the more basic ones. My evidence is incredibly limited and anecdotal, but there's good logic behind it. American Eagle became extremely popular in the 1990s and 2000s. The people that grew up loving the brand are now well into adulthood and even middle-aged. No one told them they had to stop liking AEO when they turned 26. In 2006, American Eagle was named the number one brand among college students. People who graduated college in 2006 are now at least 30 years old. Guess what, American Eagle? Some, maybe many of those people still want to buy your clothes! Wouldn't you rather have lifelong customers, as opposed to customers that right now, you are hoping won't buy your clothes once they turn a certain age? These people may still love your brand so much that they would buy it for household items, accessories, and their children of all ages as well. American Eagle management should take some time to study this idea. They may have a huge demographic just waiting for a few advertisements to tell them that it's still alright to love the AEO brand.

When it comes to being the most trendy, popular brand among teens and young adults, American Eagle has been there, done that. History tells us that once you've reached the top of that particular mountain and come down, you don't easily make it back to the top. If you fall hard like some brands, you may survive (possibly after bankruptcy), but be relegated to being the recognizable, once cool brand that is now found in Walmart (NYSE:WMT). Does anyone else remember Ocean Pacific being super cool, and kind of expensive? I certainly do.

Investors should realize that now is the time to give company management feedback about their strategy, leadership decisions, and other concerns you may have. It's easy for teen fashion brands to fall out of favor and never recover. It probably doesn't take many missteps for this to occur.

The old guard, since the departure of Robert Hanson, has mentioned getting back to marketing support for core styles and products. But that may not be enough to reverse the company's fortunes. While I don't agree with some of the conclusions, and have no way to verify any of the information contained therein, this recent article by Buzzfeed certainly paints the picture of a bunch of men in their 60s and 70s who are convinced that what worked in the past will work in the future. But successful companies need leaders with vision. Leaders need to be able to see the truth about their current situation, and to be proactive in repositioning their brand and strategy, when necessary.

American Eagle's leadership seems to be all about making small moves designed to keep them competitive in their current market. But they may be ignoring the big picture opportunity lying in front of them. They need to be able to determine where their true strength lies, and capitalize on that, rather than chasing the teen fashion wind wherever it may blow.

I love that this company's leaders have a conservative outlook on managing the balance sheet, returning cash to shareholders, and returning to core styles and products in their marketing. I don't like that they might be stuck in their ways, or possibly afraid to change their strategy in a major, and much needed way. Further, I would like to see the company go beyond just attempts at a turnaround in the teen space, into the realm of repositioning themselves as a go to brand for American consumers of all ages. That is my opinion. But of course, I could be wrong. What do readers think?

Disclosure: I am long AEO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.