Solid Earnings Report Gives American Eagle Shares Wings

Mar. 8.12 | About: American Eagle (AEO)

American Eagle Outfitters (NYSE:AEO), the apparel and accessories retailer, announced its fourth quarter results Wednesday. Shares traded 6% higher to close at $15.54 as the company made some encouraging comments about the start of the year and its general outlook for 2012.

Fourth quarter results
Sales for the final quarter of 2011 grew 14% to $1.04 billion, with comparable store sales increasing 10%. Gross profits where essentially unchanged at $356 million as gross margins collapsed from 39.4% to 34.1%
This margins squeeze was mainly attributable to cost inflation as well as severe mark downs during the holiday season.

Consequently earnings came in at $51 million or $0.26 per share after the company also took a $21 million impairment charge. Excluding the impairment charge, earnings came in at $0.35 still down 20% compared to last year's $0.44 per share.

For the first quarter of 2012 American Eagle expects to report earnings per share of $0.08-$0.10, driven by a solid start in February. This compares to $0.10 expected by analysts and $0.14 reported last year. For the full year the company expects a modest increase in sales combined with margin improvements, although increased product costs will continue to depress margins for the first half of the year.

Long term problems
Shares peaked in their low thirties in 2007. Since those days shares have continuously fallen and have stabilized in the $8-$18 trading range over the last couple of years. If we look at the financial overview of the last four years we can easily see why. Revenues remains constant at around $3 billion, however margins have collapsed. The company reported negative earnings growth for three years in a row now as net margins have fallen from 13.1% in 2008 to 4.7% in 2011.

The margin collapse is largely attributable to the recession during which consumer spending has slowed down dramatically.

Investment thesis
American Eagle Outfitters is valued at roughly $3 billion. If we subtract the comfortable $750 million cash balance from that and keep in mind that the business has no long term debt, the company becomes quite attractive. With operating assets valued at $2.25 billion this implies an investor pays 0.8 times annual revenue and roughly 16 times earnings. However, if the company manages to slightly increase revenues and restore margins to 6%, the price-earnings quickly drops to merely 11 times.

The outlook for margin improvement should support the stock in the coming months. I am a speculative buyer to make a quick buck seeing the stock trading near $20 in the short term. If shares do not recover that quickly I will still receive a healthy 2.8% in dividends per year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.