American Eagle: Value Play Or Current Troubles To Stay?

Jun. 4.14 | About: American Eagle (AEO)

Summary

American Eagle's Q1 results demonstrate that the company is in decline.

Its value proposition no longer meets the demands of the ever-changing teen retail space.

American Eagle has not been able to keep up with the increased competition from trendy and lower-priced retailers H&M and Forever 21.

Even though it is in decline, restructuring could save the company.

American Eagle's Troubles

The company recently reported disappointing Q1 results. Revenue came in at $646.1 million, which fell short of consensus estimates of $647.7 million. This represents a 5% decline from last year's Q1 revenue of $679 million. A major contributor to the reduction in revenue was a 10% decrease in comparable store sales, double last year's 5% decline in comparable store sales. Gross profit declined by 15% in part because of the aforementioned decline in sales, but also due to an increase in cost of goods sold. COGS increased from 61.2% to 65.1%. Earnings per share came at $0.02 better than the projected $0.00, but well below last year's Q1 EPS of $0.14.

Due to disappointing performance at various American Eagle (NYSE:AEO) stores, the company closed 20 store locations, 14 of them being their Aerie brand stores. Furthermore, the company announced that it plans to close an additional 150 underperforming stores over the next three years. The poor Q1 results have been reflected in the company's stock price, which is currently trading at $10.62, down 47.50% from its 52-week high of $20.23. American Eagle currently trades at a trailing P/E of 34.82, which is well above the market average, demonstrating that the stock is still not cheap.

The teen retailer space has become highly competitive and will continue to become even more competitive as there are relatively few barriers to entry. American Eagle and similar competitors Abercrombie & Fitch (NYSE:ANF) and Aeropostale (NYSE:ARO) are losing market share to hip, lower-priced teen retailers H&M and Forever 21. American Eagle, along with Abercrombie & Fitch and Aeropostale, continue to sell clothing with their logo and name plastered all over it. While this may seem like a smart marketing ploy to build a strong brand name, the majority of teenage consumers are no longer interested in brand names and logo-laden clothes have fallen out of style. It is no longer "cool" to wear American Eagle.

Instead, teenagers prefer high-style, low price clothing - both of which can be found at H&M and Forever 21. The price for a basic blue short-sleeve t-shirt at American Eagle is $15.95 at H&M it is $5.95. So for the price of one t-shirt at American Eagle you can buy almost three at H&M. As it stands right now, American Eagle has not differentiated and has no competitive advantage over trendy retailers H&M or Forever 21 because the company has not kept up with the times. Its product line has clearly fallen out of favor among teenagers and its prices are not even close to being competitive.

American Eagle has lost touch with its customer base. As a result, American Eagle will continue to lose customers to H&M, Forever 21 and other similar retailers because their value proposition no longer meets the needs of the teenage consumer.

American Eagle's Bright Spots

Management recognizes that company has lost touch with its customer base and is in the process of restructuring. The restructuring has started with the previously mentioned store closings, which are estimated to save the company $10 to $15 million a year. Even though the company closed numerous stores during Q1, the company actually added eleven stores, three of them in expanding markets: two in Mexico and one in China.

Another strength is that the company has zero debt. Also, American Eagle has a robust yield of 4.6%; however, is this dividend feasible with the current state of the company? Additionally, the company has a relatively low forward P/E of 14.16, which means the company could be undervalued relative to the future.

The Final Word

If you believe in American Eagle's management and their ability to restructure the company to meet the ever-changing demands of teenagers, then American Eagle is a compelling buy at these levels. However, if you think the company will continue to struggle to successfully position itself against trendy, lower-priced retailers like H&M and Forever 21, then it'd be best to stay away.

Personally, I do not see any intriguing reason to buy American Eagle at this point. As such, I recommend waiting to see how the restructuring of the company pans out and then evaluating shares at that point.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.