Investors Should Be Disappointed With American Eagle's Subpar Dividend Policy

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About: American Eagle Outfitters, Inc. (AEO)
by: Robert & Sam Kovacs
Summary

American Eagle has a pristine balance sheet.

The stock's dividend is super safe, and could easily be increased multiple times.

Yet, management chose to refrain from increasing dividends.

While the stock seems appealing for capital gains, I cannot advise dividend investors to buy any shares.

Written by Sam Kovacs

Introduction

American Eagle Outfitters (AEO) has a dividend yield of 2.76% and is trading at $19.96 per share. Based on my M.A.D Assessment, AEO has a dividend strength score of 47 and a stock strength score of 99.

This article will present and discuss the factors which show why I believe that dividend investors should avoid American Eagle Outfitters for the foreseeable future.

Source: mad-dividends.com

American Eagle Outfitters is a retailer of apparel and accessories that also offers personal care products. It sells its products in stores as well as online. It operates stores in the USA, Canada, Mexico, Hong Kong, China and the UK.

This article will be divided into two parts: dividend strength and stock strength.

I look at stock and dividend strength as 2 distinct subjects. A high dividend strength score indicates that the company has a good combination of dividend safety, dividend yield and dividend growth potential. Stocks which rank high in stock strength are likely to produce good returns for capital gain investors. Dividend investors can achieve the best results by picking stocks with a good combination of dividend strength and stock strength.

Dividend Strength

Dividend strength can be broken down into a) dividend safety and b) dividend potential.

Both are equally important, and both will be analyzed within this article.

To evaluate the dividend safety, I will look at payout and coverage ratios. The company's dividend potential is measured by looking at the current dividend yield, the dividend's historical growth, as well as the changes in the revenues and net income over the recent years.

Dividend Safety

37% of American Eagle Outfitters' earnings are paid out as dividends. This is a more attractive payout ratio than 53% of dividend stocks.

Operating cash flow payout also gives a good idea of a company's ability to pay its dividend, and gives a more complete picture than simply looking at the earnings payout. AEO pays 21% of its operating cash flow as a dividend, putting it ahead of 63% of dividend stocks.

To finish my assessment of AEO's payout ratios, I turn to free cash flow payout, which gives an idea of the company's ability to pay its dividend after paying for its Capex. American Eagle Outfitters has a free cash flow payout ratio of 35%, a better ratio than 60% of dividend stocks.

American Eagle Outfitters’ payout ratio is satisfying according to these 3 metrics.

31/01/2015

30/01/2016

28/01/2017

03/02/2018

02/02/2019

Dividends

$0.5200

$0.5200

$0.5200

$0.5200

$0.5500

Net Income

$0.42

$1.11

$1.16

$1.13

$1.47

Payout Ratio

124%

47%

45%

47%

38%

Cash From Operations

$1.73

$1.89

$2.01

$2.22

$2.64

Payout Ratio

27%

27%

25%

23%

21%

Free Cash Flow

$0.48

$1.04

$1.12

$1.26

$1.55

Payout Ratio

107%

50%

47%

41%

36%

Source: mad-dividends.com

Analyzing interest and debt coverage ratios along with payout ratios gives us an idea of the payout ratio's stability. If a lot of the company's earnings go towards paying interest, the financial leverage makes the company's bottom line more affected by variations in revenue.

AEO has an interest coverage ratio of 0x, since it carries no debt whatsoever. This is surprising since most companies carry at least some debt, but not AEO. This considerably increases the safety of the dividend which is already well covered by cash flow and earnings.

Looking at payout and coverage ratios together would suggest that AEO’s dividend is very safe.

Dividend Potential

I then move on to analyzing the company's dividend potential (i.e.: its ability to pay us a good dividend which grows at a satisfying rate).

Source: mad-dividends.com

American Eagle Outfitters’ dividend yield of 2.76% is better than 58% of dividend stocks.

AEO has a 5-year dividend CAGR of 1%. Dividend increases are sporadic and inconsistent. This is a shame. The company clearly generates enough cash flow to have a more appealing dividend program, yet management have not committed to one.

The 2.76% yield pales when you consider any dividend growth to be a wildcard.

Source: mad-dividends.com

Over the previous 3 years, American Eagle Outfitters has seen its revenues grow at a 5% CAGR and net income by a 6% CAGR. It is important for a company to continue growing revenues and net income in order to continue paying and, importantly for a dividend investor, growing its dividends.

Source: mad-dividends.com

If the company can continue to grow its revenue and net income at the current rate, AEO’s dividend has weak potential for growth. While all the elements seem to be in place for the company to afford multiple generous dividend hikes, management has decided not to.

Dividend Summary

The combination of the data presented above gives AEO a dividend strength score of 47/100. Unfortunately, AEO doesn’t qualify as a good candidate for dividend investors because of its lackluster dividend growth.

Stock Strength

Looking at dividend strength with no regard to other fundamental factors is a mistake many dividend investors make. To pick the most attractive dividend investments at any given point in time, we must also focus on other factors.

These fundamentals are what determine a company's stock strength score: value, momentum, financial strength and earnings quality.

To assess a company's stock strength score, I look into the fundamentals underlying these factors separately.

Value

It has been proven time and time again that undervalued stocks outperform overvalued stocks. To assess value, I look at a company's P/E, P/S, P/CFO and Shareholder Yield. The combination of these ratios give a stock a value score out of 100.

  • AEO has a P/E of 13.58x
  • P/S of 0.85x
  • P/CFO of 7.54x
  • Dividend yield of 2.76%
  • Buyback yield of 2.75%
  • Shareholder yield of 5.51%

These values would suggest that AEO is more undervalued than 94% of stocks, which is satisfying. Undervalued stocks tend to outperform the market, and AEO is extremely undervalued according to these metrics.

Value Score: 94/100

I also draw PE lines over a stock chart, very much like Peter Lynch would do while running the Magellan fund. By doing so, investors get an idea of the company's PE range, and therefore serves as an indicator of potential downside and upside.

Source: mad-dividends.com

The chart above suggests that AEO is trading below its 5-year average PE. In fact, a re-rating to its average PE of 21 would imply a 50% increase in price.

Momentum

As stupid as it sounds, stocks which have appreciated recently are the most likely to continue going up. Most dividend investors disregard momentum and are happy buying on the way done.

I believe this to be an investing mistake which can have dire consequences. Buying losing stocks is never a good idea, even if your main motivation is to receive a dividend.

American Eagle Outfitters' price has increased 0.20% these last 3 months, 3.15% these last 6 months, but is down 13.59% these last 12 months and now currently sits at $19.96.

Source: mad-dividends.com

AEO has better momentum than 51% of stocks, which I find to be slightly unsatisfying. The stock is down and has underperformed the market these past 12 months. Year to date, it has been mostly trading sideways. As pressure from the trade war persists, apparel and retail stocks with average momentum will have a tough time getting any love from the investment community.

Momentum score: 51/100

Financial Strength

Stocks with good financial strength will have reasonable levels of debt, low liability growth - or even decreasing liabilities - and will produce high levels of cash flows in relation to their liabilities.

Financially strong stocks have historically performed a lot better than companies with weak financials. It goes without saying that investors should be extra careful with stocks which dramatically increase their financial leverage.

AEO's Debt/Equity ratio of 0.5 is better than 81% of stocks. American Eagle Outfitters’ liabilities have increased by 8% this last year. Operating cash flow can cover 74.2% of AEO's liabilities.

These ratios would suggest that American Eagle Outfitters has better financial strength than 90% of stocks. The company’s liabilities are so low, the company is virtually not leveraged. While liabilities have increased, the company has great cash flow coverage.

Financial Strength Score: 90/100

Earnings Quality

Stocks with high earnings quality will have low levels of accruals and will depreciate their capital expenses quickly. Their assets will also generate large amounts of revenue.

American Eagle Outfitters’ Total Accruals to Assets ratio of -25.1% puts it ahead of 86% of stocks. 89.1% of AEO's capital expenditure is depreciated each year, which is better than 38% of stocks. Each dollar of AEO's assets generates $2.1 of revenue, putting it ahead of 95% of stocks. Based on these findings, AEO has higher earnings quality than 93% of stocks.

Earnings Quality Score: 93/100

Stock Strength Summary

When combining the different factors of the stock's profile, we get a stock strength score of 99/100 which is fantastic. Very few stocks combine solid fundamentals, a growing income statement and great value. All AEO lacks is a little momentum for the stock to get in gear and take off.

Conclusion

With a dividend strength score of 47 and a stock strength of 99, American Eagle Outfitters is a subpar choice for dividend investors. While the stock’s fundamentals and value make it a prime candidate for capital gains investors, the company would benefit from a generous dividend program.

Why this hasn’t been considered is beyond me, since approval from the dividend growth investment community could be the catalyst the stock needs to appreciate rapidly.

If the company were paying out a dividend twice as large, it could get away with not growing the dividend. At 2.7%, with no dividend growth in sight, no income investor is ever going to get excited.

Note: To learn more about the Machine Assisted Dividends (M.A.D.) methodology, you can read this post, which my father Robert Kovacs published. All financial data from my company mad-dividends.com is sourced directly from the SEC, whereas pricing data comes from IEX.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.