American Eagle Outfitters: Not Much Room For Error

American Eagle is a casual clothing retailer mostly designed to target 15 to 25 year olds and concentrating on value offerings. It is currently in the process of expanding to target 25 to 40 year olds with its MARTIN + OSA brand, and is also working on expanding its aerie line which sells dorm wear and intimates for females between the ages of 15 to 25 years old.

It also operates AE.com which sells its American Eagle and aerie clothing lines. AE.com has also been a major growth driver and in 2006, sales at AE.com rose 48%.

American Eagle's retail stores have been in existence since 1977. It has been growing at a very brisk pace and its revenue has grown from $406 million in 1998 to almost $2.8 billion in 2006.

Industry

It is a very competitive industry as fashions can come and go without notice. Clothing is one of the three basic needs for humanity, so this is a plus. Also, its clothing is mid-priced so economic trends should not significantly affect American Eagle. The industry is also very sensitive to weather trends, which can also affect results. American Eagle products are significantly cheaper than Abercrombie & Fitch, and a bit more expensive than Aeropostale. However, compared to Aeropostale, the quality of American Eagle's clothing is significantly better.

Company

American Eagle has been growing steadily, but its sales have been growing at a spectacular rate. It is currently testing out its aerie and MARTIN + OSA lines in experimental markets. Its American Eagle line is slowly saturating, so MARTIN + OSA and aerie will be its main drivers of future growth. The key metrics that American Eagle measures its stores by is sales per square foot and comparable store sales, with both of these metrics recently showing positive signs. Since it has been selling clothes over 3 decades with great success, it has demonstrated that it has a good knowledge of trends in the clothing industry.

Valuation

It has over a $1 billion in cash, short-term investments, and long-term investments on its balance sheet. There is no long-term debt. It is trading at a trailing Price/Earnings ratio of 17.18. According to Yahoo's Apparel Stores industry, the average trailing P/E is 18.4. It pays a dividend of $.30 a year which is a yield of about 1%.

American Eagle has been buying back stock, but there is nothing to be excited about. During its 4th quarter conference call (courtesy of www.seekingalpha.com), Joan Hilson, who is the Executive Vice President and Chief Financial Officer, said that, "The philosophy that we have on our stock repurchase program is we offset a dilution related to stock option exercise."

Its return on equity has been very strong, averaging 27.83% over the past 10 years. According to Yahoo's Apparel Stores industry, the average return on equity is 19.7%. Its EBITDA is $717.1 million and it is trading at around a 7.5x Enterprise Value/EBITDA ratio.

Technicals

Its uptrend that started in late 2005 has been broken and it has been in a down trading range of 28 to 34 during the past 7 months. RSI and MACD have been both trending down since October of 2006. The 20 and 50 day moving averages have also been trending down since early March, and the 20DMA crossed below the 50DMA in February for the first time since December of 2005.

The three moving averages are currently right next to each other, and AEO is trading below all of them. It is also below its 200DMA for the first time since February of 2006. AEO's first major support is at $28 a share, which from the current trends does not seem like it will hold. The next major support is around the $24 area and it looks like it's slowly breaking down.

Conclusions

American Eagle seems to be fairly priced, or just a bit undervalued at these prices when using Price/Earnings as a metric. The industry is trading at an average trailing P/E that is just a bit higher than AEO's. There is not much room for error if there is a slowdown in its growth.

Management has shown that it can perform and beat expectations, but its 15% yearly earnings growth will be harder to reach as a mid cap compared to when they were a small cap. The stock price will continue to go up as long as management can reach growth expectations that were set by both itself and the analysts, but if there is a slowdown in its growth, the stock will tumble. Also, keep in mind that the technicals are changing so that could be a hint of what is coming in the future.

Disclosure: The author has no position in AEO.