American Eagle's Down But Not Out

By Stephen D. Simpson, CFA | May 25, 2011 AAA

Nothing lasts forever in retailing; anyone younger than 35 probably has no idea what a "blue light special" is and once-popular retailers like Montgomery Ward and Service Merchandise are long gone. Even on a less dramatic level, there is a definite cyclicality to the retail business - few companies can manage their merchandising without missteps for years at a time, and that has been especially true in teen retailing.

TUTORIAL: Top Stock-Picking Strategies

That said, it seems like too many analysts and investors are counting American Eagle Outfitters (NYSE:AEO) out of the fight prematurely. True, the company's same-store sales are not good right now, but this retailer is far from a goner and new leadership could be the catalyst to a more significant turnaround. (For background reading, check out The 4 R's Of Retail Investing.)

American Eagle's Disappointing Start to the Fiscal Year
There wasn't much good news for American Eagle to crow about this quarter. Revenue dropped 6% (and missed estimates by more than 4%) as comps fell a surprising 8%. Sales were especially weak in women's merchandise as comps here were down 10% (versus a 5% drop in men's). Online sales were not much help either, as sales rose just 3%.

Profitability offered a little bit of hope. Gross margin did fall nearly two full points as reported, but core merchandise revenue actually improved 70 basis points as higher costs for items like rent pushed the overall number lower. American Eagle also managed to control operating costs fairly well, as SG&A dropped 6%. Despite all of this, operating profit still fell almost 28%; a lower tax rate and higher "other" income propped up the bottom line number.

AEO's Quarter Better Thank It Looks
Compare AEO's quarter to that of other retailers and the company's numbers start looking a little better. Gap (NYSE:GPS) did better on the top line (down 1%), but margins fell off more sharply (although Gap's operating margin is quite a bit higher). Likewise, Aeropostale (NYSE:ARO) reported a significant drop in revenue and profitability. Although Urban Outfitters (Nasdaq:URBN) sported better sales performance, margins were a problem here too. In fact, Abercrombie & Fitch (NYSE:ANF) stands out as a rather rare exception in the group.



MORE RELATED READING:



Careful Management a Mixed Blessing
American Eagle may have actually been a bit too cautious for its own good this quarter. Inventory was up just 2%, and was actually flat on a per-square-foot basis. Given the increasing cost of merchandise, it seems like American Eagle ran extremely lean this past quarter. In some respects, that's good - it limited the company's need to discount and mark down merchandise to keep it moving. On the other hand, it means it is also likely that the company missed out on some potential sales by being out of stock.

Can American Eagle Stay in the Game?
Nothing about the retail world is getting any easier. Unemployment and poor wage growth may be a problem today (whether kids can't get jobs or parents have less money to give them), but the competitive threat of fashionable value chains like H&M (OTC:HNNMY) is a serious threat for tomorrow. What's more, there are plenty of other teen-oriented retailers, like the aforementioned Abercrombie, Urban Outfitters, Aeropostale, and Buckle (NYSE:BKE) competing for teen eyeballs and dollars.

Still, American Eagle has not survived this long through sheer luck. The company has a brand that holds some value and it may be closer to a revival than the bears assume. The company is actively looking for a new CEO and although that transition holds risk (particularly if the new CEO wants to go in a significantly different direction), it could rejuvenate the company.

The Bottom Line
If retailers like Hot Topic (Nasdaq:HOTT) and Pac Sun (Nasdaq:PSUN) can hang on for as long as they have, American Eagle likely still has a few more tricks up its sleeve. Better still, the stock's valuation is quite unassuming today. If the company can deliver just 3% revenue growth and some minor improvements in margin, it could be worth 40% more than its current price. That seems like a gamble worth taking for patient investors who don't expect another recession in the next year or two.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Analysis
  1. These stocks have been weak, and despite rallies, investors might be better served by selling or shorting as opposed to buying.
    Chart Advisor

    Time To Take Profits On These 4 Rallying Stocks?

  2. With its huge population and booming economy, China is tops for many emerging markets investors. Here's a leveraged ETF for those who want to double down.
    Stock Analysis

    This Leveraged ETF Is For China Bulls

  3. Chart Advisor

    Is Natural Gas About to Tank?

  4. Chart Advisor

    Is It A Breakout? See The Point-And-Figure Chart

  5. Chart Advisor

    These Stocks Offer Range-Trading Opportunities

Trading Center