Heightened Commodity Costs Pressure American Eagle

Jun. 1.11 | About: American Eagle (AEO)

American Eagle Outfitters (NYSE: AEO) targets the 15-25 year-old demographic, and competes with other specialty apparel retailers like Gap (NYSE:GPS), Abercrombie & Fitch (NYSE:ANF) and Aeropostale (NYSE:ARO). We estimate that American Eagle brand stores are the largest value driver for the company, contributing around 47% to our price estimate for American Eagle Outfitters stock.

Our price estimate, at $19.92, stands well ahead of market price.

American Eagle First Quarter Results

American Eagle recently reported first quarter 2011 earnings. Net sales for the quarter were down 6% as compared with the same period last year. Comparable store sales were down 8%, but internet sales increased 3%. The company’s cost control initiatives coupled with improved merchandise margin provided some support to its profits in the first quarter. [1]

Chart created using Trefis' app

Like many of its peers, American Eagle has been facing profit margin pressure due to increasing cotton prices over the last year. The increase in cotton prices has largely been driven by imbalances on the supply side with a combination of droughts in China, the largest producer, and unseasonal rains in India, the second largest producer. Unless cotton prices fall, many of the apparel retailers in the U.S. are expected to pass the increased cotton costs on to consumers in the form of higher retail prices. This would put further pressure on demand, as consumer spending has been slow to pick up after the recession. [2]

We expect EBITDA margin for American Eagle stores to fall in the near term, but then improve in the longer term, with stabilizing supply and demand for cotton.

Notes:

  1. American Eagle reports first quarter 2011 results
  2. When Will Cotton Finally Settle Down

Disclosure: No positions