Time To Buy American Eagle's Turnaround

Aug.25.14 | About: American Eagle (AEO)


American Eagle's latest results show that the company is indeed turning around.

American Eagle is focusing on fresh inventory, e-commerce growth, and new stores to power its comeback.

American Eagle's debt-free balance sheet and better bottom line growth in the next five years are positive indicators that investors should not ignore.

In spite of weak numbers during the second quarter, American Eagle Outfitters' (NYSE:AEO) stock surged on account of better-than-expected results. In fact, on a year over year basis, the company was down on almost all metrics. But, investors were pleased to see that American Eagle managed to outperform Street expectations. The stock has gained a remarkable 25% in the last five days, and if the company continues to execute its smart strategies, it will continue getting better.

In renaissance mode

American Eagle's renaissance can be gauged from its recent results. Although its revenue declined 2% to $711 million, but it was way better than analysts' expectations of $689.9 million. Its earnings also dropped considerably to $0.03 per share from $0.10 per share last year. But, the bottom line performance was significantly better than the consensus expectations of a break-even. Going forward, the company expects third-quarter earnings to be in the range of $0.17 to $0.19 per share, which is in line with the consensus of $0.18 per share.

The company is showing signs of improvement, driven by better inventory management. In fact, even though American Eagle saw various headwinds during the quarter as its spring and summer assortments did not meet customers' expectations, it did well overall. American Eagle managed to clear excess inventory, setting itself up for better times ahead.

Learning from its past mistakes, management seems to be well-prepared for the coming holiday season with consistent product lines that are expected to meet customers' expectations. It has enhanced quality, and is also improving on merchandise presentation.

How the turnaround is progressing

To execute its turnaround, American Eagle is focused on three aspects. These include strengthening customer engagement, customer service, and operational efficiencies. Management has made investments in these areas as we will see shortly, and these moves are expected to power its growth in the long run.

The retailer has started its new manufacturing facility in Pennsylvania, which is equipped with improved features to increase operational efficiency. This facility will now enable the company to meet demand from its online business and speed up delivery. Management also plans to add served distributions in the facility that will bring down its cost by around 10% in the coming months.

American Eagle is also bringing various changes to its e-commerce platform. It has enhanced its digital site, including the new denim shop, and incorporated a 360 degree view of the products. It will also re-launch its mobile app, which will make the shopping experience more intuitive and simplified for customers.

On the promotion side as well, the company has various strategies under its sleeve. According to management, "We've begun piloting a new point of sale system that would be rolled out in 2015 for value improved speed integration with our e-Commerce business and upgrade mobile check-out capabilities." Moreover, once its investments are complete, capital spending will be reduced and this will improve its earnings performance in the future.

In addition, American Eagle is working on international expansion. The retailer anticipates entering the U.K. market by November. Initially, it plans to roll out three stores at some of the most popular shopping destinations in England that will be owned and operated by the company itself.

Going forward, American Eagle plans to rely less on promotions, a move that would increase its margins. Management believes that its inventories are in good shape and are well-aligned for the future. With emerging trends in the market, the company is also changing its styles accordingly, with improvement in fabric quality as well. Some of its brands, such as Aerie, are picking up momentum, and the company expects the same trend to continue going forward.

Fundamentals and conclusion

From a valuation viewpoint, American Eagle looks expensive with a trailing P/E of 42.56. But, its forward P/E looks impressive at 17.54, reflecting an improvement in the bottom line. In addition, American Eagle is debt free, which means that it can freely invest in its turnaround initiatives as it has a cash position of $327 million. Also, in the next five years, American Eagle's bottom line is expected to grow at a rate of 8.6%, way better than an erosion of 4% seen in the last five years.

As management is undertaking various strategic moves to turnaround its present situation, American Eagle Outfitters seems to be a good investment option.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.