Future at Abercrombie and American Eagle Not So Grim

A closer look at clothing retailers American Eagle Outfitters (AEO) and Abercrombie & Fitch (ANF) suggests the future may be less grim than expected, especially for ANF.

On Wednesday, American Eagle Outfitters announced fourth quarter earnings of 66 cents per share in line with analyst estimates. During the conference call, management mentioned several encouraging items. For example, they continue to take disciplined steps to control inventory in this tough environment. Also, the company re-affirmed Q1 earnings guidance (which is in line with analyst estimates), valuation is attractive (forward P/E is near historical trough levels), the balance sheet is strong (zero debt), and AEO continues to rank well with teens.

On the negative side, AEO continues to struggle in women's apparel (which makes up 60% of their business), and there is question as to where future growth will come from considering the industry is very mature. Improving women's apparel is one growth opportunity, as is expansion of the aerie brand. International growth is another opportunity, but the American Eagle brands seem to have less international appeal compared to Abercrombie & Fitch.

Abercrombie & Fitch seems to have a strong enough brand to achieve significant success in international markets. For example, according to Bloomberg, ANF's first European venture (near London's Savile Row) charges twice as much as US stores, and has sales of about $4500 per square foot, matching its main shop on New York's Fifth Avenue. Based on early international success, Abercrombie has been laying the foundation for an accelerated international expansion (there is talk of store openings in Tokyo, Paris, Hong Kong, Dublin, and Shanghai), and some analysts are predicting that international could account for 25% of the company's sales within five years.

Abercrombie also has a variety of other positive things going for it. For example, ANF has $650 million in cash on its balance sheet (out of $2.5 billion in total assets), and it generates a free cash flow yield of around 5%. Also, ANF has a dividend yield of 1%, and it will likely use its excess cash to increase the yield AND repurchase shares. Currently, ANF trades at 13.1 times January 2009 estimates, which is a discount to its historical average of approximately 15. Similar to AEO, ANF has operating margins around 20%, which is considerably better than the industry average of only 5%. AEO is currently trading near its 52 week low, while ANF has held up slightly better over the last year. However, I suspect both companies are undervalued, and it will be interesting to watch them over the coming year and beyond.

Comments

[SDA]

Girls pick their clothes based on the style and shape and what is trendy. They do not rely on the Brand Name like AE or Abercrombie n fitch to carry an outfit. So, therefore, these stores have to have cheaper and very trendy stuff. Wet Seal, Target and other retailers have figured this out. Girls want a lot of clothes and they know they can get a lot of cool stuff at these kind of retailers. Mom and dad are ok with big purchases because of the volume is so high.
On the other hand, Guys don't care to have alot of clothes, so the only thing they want is the brand plastered across their hoodie. Meanwhile mom and dadare ok with spending the extra, because they don't buy alot for their sons.
In conclusion, these retailers will probably never the girl market unless they carry a ton of trendy and less expensive stuff for girls.
One Stayhome moms opionion
SDA

[mark.d.hines]

SDA- Thanks for your comments. That is good perspective.

[canyonal]

SDA -interesting points. my 2c worth as a father of 2 teenage girls. i bought shares in aeo as i was spending so much thro the door. speaking to their friends they break up into tribes, following various brands, identifying with the style generally offered.

iget the feeling that aeo has become the new gap.. too mature to grow rapidly but a standard for many wardrobes. now if aeo could grow internationally for which i see no reason not to. having seen how popular the clothes are in europe (ae clothes are always a good standby present for teen to twenties).

maybe they could buy lululemon lulu?
ca

[User 167169]

I decided today I was going to invest in either A&F or Am Eagle. I have studied, etc. Some will say the way I made my choice is crazy, but based on this particular brand and purchase, this was probably THE ONLY way for me. I obviously wouldn't do this if I was looking to get into the energy sector! :) Anyway, I yelled up and asked my 18 year old daughter which store and clothes she and her friends like better. She is a high school senior and soccer player at an affluent high school. She said she and her friends like AE. Sold.

[mark.d.hines]

Great point User 167169. The folks at Pali Research used the same technique as you, but they surveyed teens all across America by giving them $100 mall gift cards that were good at stores like Abercrombie, American Eagle, Wet Seal, Hollister, Pac Sun, Aeropastale, etc. American Eagle was the hands down winner! Check out their research/documentary if you have access:

paliresearch.com/blog/.../


www.streetinsider.com/...