It is almost hard to believe that American Eagle Outfitters (NYSE:AEO) hit just $10 last year. Retail was seriously out of favor with investors last summer, but as we all know by now, sentiment on the retail names really couldn’t be much better today. Many stocks – like AEO – have doubled or better off of their 2017 lows, but unlike others in the apparel retail space, AEO doesn’t look ridiculously expensive today. The Q4 report produced good results and guidance was above consensus well, so if you’re looking to own a mall retailer, perhaps AEO will fit the bill.
Comps were hot and aerie led the way
Total revenue was up 14% in Q4, helped along by an extra week that wasn’t present in last year’s Q4. AEO’s store count was roughly flat as it continues to open and close units, but it is large enough that unit count isn’t a real source of growth. However, Q4 produced some prodigious comp sales numbers and that powered total revenue higher.
Total comps were up 8% in Q4 as the American Eagle brand posted a 5% gain, but aerie was up a staggering 34%. I don’t recall ever seeing a comp number that high, but even if it has been done before, it is tremendously remarkable. It also comes on the back of last year’s Q4 comp of 17% for the aerie brand, something which is just difficult to fathom. The AE brand is no slouch and posted a 2% gain for the year, but in comparison to aerie’s 27% 2017 gain, it is peanuts. I couldn’t be more impressed with AEO’s revenue performance in Q4 even if you exclude the gains from the extra week.
Promotions spoiled some of the fun
Unfortunately, it appears at least some of the comp gains were driven by weaker pricing as gross margins fell 80 bps in Q4. Management cited higher promotional activity as well as higher labor costs and shipping expenses as factors that sent margins lower. The shipping/labor cost margin reduction has become a common theme for retailers this earnings season so no surprise there, but the level of promotional activity is a bit surprising. AEO is obviously seeing strong demand, but apparently management felt the need to run more promotions than last year. That no doubt led to at least part of the comp gains we saw, but one wonders how well AEO would have done without them. I never want to see a highly promotional stance from any retailer, but at least in AEO’s case, the 80 bps of damage is palatable.
SG&A leverage saves the day
That is because SG&A costs were leveraged down 60 bps in Q4 in part due to the extra week but also because comps helped leverage down spending as a percentage of revenue. That means operating margins were down 20 bps, and while that’s not great, the huge sales increase more than made up for it in terms of dollar earnings. Adjusted earnings were up 13% in Q4 so it was a nice result, but far from perfect.
Another raise and the yield is 3%
AEO also raised the dividend by 10% and the forward yield is now right at 3%. That’s actually very interesting from an income stock perspective as AEO has lots of extra cash and is producing more and more of it; should AEO sell off, the yield could be sizable to say the least. As of now, the 3% yield is a bonus for those that like the stock anyway and is getting to the point where income investors may sniff around. Just know that with AEO you get a management team that believes dividends are important and unless disaster strikes, the payout will continue to rise.
The stock looks reasonably valued here
AEO also buys back some stock, and at the end of Q4, the share count was about three percent lower than it was at the end of last year. That’s not huge, but every little bit counts and a three percent reduction is certainly respectable.
Guidance for Q1 was slightly above consensus and analysts have AEO hitting $1.35 this year, good for an increase of 16%. Part of that gain will come from tax reform and some from the buyback, but the part I’m interested in is comps and margins. Q1 guidance would suggest management is optimistic and indeed, commentary from the press release says as much. The investment in additional inventory for aerie suggests also that its rather incredible run of comp sales gains likely isn’t over, but as we move throughout the year, keep an eye on how much promotional activity AEO engages in. I don’t doubt that sales will rise this year despite the built-in tailwind from the lack of the extra week from 2017, but margins will really be in focus. Overall, I think AEO is well positioned to deliver $1.35 and potentially more given Q1 guidance, but given where the stock is now, I don’t think that even needs to happen.
We are trading at just 14 times this year’s earnings, and while AEO doesn’t necessarily have enormous runways of growth ahead of it, comps are rising and the share count is shrinking. It doesn’t take much to justify a forward PE of 14 even if margins are a bit of a wild card so after what looks like a pretty decent report to me, AEO and its 3% yield are looking rather good.
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