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American Eagle Outfitters' Wings May Be Falling Off

The cash flow numbers you cite are somewhat irrelevant. You need to adjust the prior year's free cash flow downward to account for the "Proceeds from sale of trading securities". Otherwise your prior year cash flow is overstated.

Looking at EBITDA-CapEx as a more comparable metric, you'll find that 2007 was actually up about 2%. I know that doesn't include some relevant working capital outflows, BUT many of those outflows were for inventory builds at the new concepts and we just can't tell if those are going to be successful yet. In any case, you either need to give them credit for sales growth or some slight working capital inflows in the next year or two if they decide to exit these concepts. They are going to get some future value out of the cash spent on inventory and new stores.

On that topic of new concepts, I will concede that it is a bad time to be spending all this CapEx on new stores ($250mm in 08). They won't be able to judge long term potential in an environment like this one, especially with an adult concept (adults are even less likely than teens to spend money on clothing during a recession). Furthermore, they're going to be able to get better lease terms by waiting and it just makes sense to tighten the belt when times get tough so that there is flexibility in case things get really bad.

There are big economic headwinds, but this company looks somewhat cheap to me. I'd love to see what assumptions you used for sales and margins to get to your rock bottom DCF price. This company has $3/share in cash and securities (the ARS are real securities which will either eventually be redeemed by issuers or held with higher interest rates). Additionally, you could cut margins by 40% and stall growth, and as long as CapEx was reigned in (no smart managers would keep spending if the environment remains weak), they could produce cash flow north of $200mm. That means they would be trading between 10-13X free cash flow (market cap adjusted for excess cash), or a FCF yield of 7-10% in a nearly worst case scenario. My opinion is that their margins and sales won't suffer that drastically, although they should fall some for sure.

Teens and parents will want fashion at decent values in these times, and that's what AEO offers (unlike ANF whose price points are much much higher). Many teens work part time jobs and spend most of their discretionary income on clothes and entertainment, not food/bills/rent/etc. I would think that should lend some stability to the business. Just my two cents...