American Eagle Outfitters Q3 Preview: What To Watch

Nov.29.11 | About: American Eagle (AEO)

Teen apparel retailer American Eagle Outfitters (NYSE:AEO) is scheduled to announce its Q3 earnings results on November 30th. [1] Though American Eagle’s stock had gained nearly 8% after the business update on November 2nd, which disclosed a net sales increase of 11% and a comp sale increase of 5%, the stock has been on a decline since then. The apparent reason behind the decline is the confusion in the market, which built up after American Eagle failed to revise its earnings guidance this quarter accordingly to a solid increase in its sales. One of the probable reasons behind this can be a decline in gross margins, which has in turn culminated into a cautious outlook in the market for American Eagle’s stock. American Eagle Outfitters competes with the likes of Aeropostale (NYSE:ARO), Abercrombie & Fitch (NYSE:ANF) and Gap Inc. (NYSE:GPS) in the teen apparel space.

Margins to remain in focus on November 30th

With the net sales and comp sales disclosed in the November 2 sales update, gross margins are expected to be center of attention. Additionally the speculations on gross margins have increased, after the revised earnings guidance issued in the sales update.

Below we take note of the factors that may positively/negatively impact the margins for Q3:

Increase in promotions to set right the comp sales may take a toll on margins:

One of the items that was on the agenda for American Eagle this quarter was to set right its comp sales. American Eagle had flat comp sales during Q2, and an increase of comp sales by 5% is certainly a bright spot for Q3. However the increase in comp sales may have come on a sacrifice in gross margins. Considering the heavily promotional nature of current apparel market, American Eagle may have to increase the depth of its promotions to attract more customers, which may weigh down on its margins. We will be keenly following this trend in the Q3 earnings release.

Although increase in direct sales and decline in cotton prices expected to provide tailwinds to margins:

On the other hand we expect American Eagle to benefit from decline in cotton prices and increase in internet revenue. Cotton prices have decreased form nearly 160 cents/pound in June 2011 to roughly 110 cents/pound in October 2011, which would certainly bring AUC for its merchandise down. Additionally direct revenues for the company have grown by 21% this quarter, which we believe will ameliorate the margins further.

Though we expect both of the above factors to impact the margins of American Eagle, which trend weighs down the other will eventually decide the course of margins.

We have a Trefis price estimate of $15.55 for American Eagle Outfitters, which is nearly 20% ahead of the current market price.Notes:

  1. American eagle to announce Q3 results on November 30, Source: American Eagle Outfitters IR

Disclosure: No positions