International Markets Opportunity For American Eagle Outfitters’ Business – Part I

Specialty apparel retailer American Eagle Outfitters (NYSE:AEO) has had a difficult time in the U.S. lately, due to its missed fashion calls, persistence with the logo business, fierce competition from fashion-forward brands and changeable consumer behavior. In 2013, the retailer’s comparable store sales declined by 6% and EBITDA (earnings before interest tax depreciation and amortization) margins plummeted by 6.5 percentage points as it ushered heavy markdowns to compensate for low store traffic. A  bleak outlook in the U.S. apparel industry and its painfully slow recovery have forced American Eagle to consolidate its domestic store fleet. However, its international business still provides some hope. While most of the retailer’s business is confined to North America, it operates about 62 licensed franchise stores in 12 countries. The store count might seem insignificant compared to American Eagle’s domestic store count, but the retailer is looking to accelerate its international expansion as it plans to open about 40 international stores this year. We believe that countries like China, Mexico, the Philippines and Thailand will play a pivotal role in American Eagle’s international business growth.

Early last year, American Eagle terminated its licensing agreements in China and Hong Kong, and assumed control over its six existing stores. Given the huge market potential, the company plans to continue its expansion in the region. China is the second largest apparel market in the world, which is set to grow at a robust pace driven by booming middle class and changing lifestyle. In 2013, American Eagle launched its first licensee store in the Philippines, where flourishing BPO industry and rising remittances are driving the apparel industry growth. Although the company has entered the region with a franchise store, it may not be long before it opens retail stores in the market. American Eagle also opened its first stores in Mexico and Thailand recently, which we will discuss in a following note.

Our price estimate for American Eagle Outfitters stands at $14.74, implying a premium of close to 25% to the market price.

See our complete analysis for American Eagle Outfitters

China

Although the Chinese apparel market is struggling currently on account of a consumer spending pullback, it is set to boom in the long term. With rising disposable income and growing urbanization, the market increased from $110 billion in 2009 to $140 billion in 2012, and is expected to touch $220 billion by 2016. ^[1] Within the market, men’s and women’s casual wear are among the biggest and fastest growing apparel segments. A 2012 AT Kearney report estimated women’s casual wear market to be at $67 billion and men’s casual wear market to be at $56 billion. The same report projected their CAGR (compound annual growth rate) for the period of 2012-2016 at 15% and 17% respectively. Fashion casual wear sales account for about two-thirds of the overall casual wear sales, which suggests that the addressable market for American Eagle is large at around $95 billion (estimated figure for 2013). The fashion casual wear market is expected to grow at a CAGR of 15% for the next few years, indicating that it will remain ahead of the overall market growth. ^[2]

During the 1990s, middle-aged Chinese consumers started switching from their work related formal uniform to casual outfits, which propelled growth in the apparel market. For over two decades, Chinese buyers exhibited great interest in lifestyle oriented clothing due to the availability of wide range of products and brands. Additionally, with rising disposable incomes and growing urbanization, their budget for branded apparel stretched. ^[3] A substantial rise in the region’s labor costs on account of labor shortage, an ageing population and increased government regulations were the primary reasons responsible for increasing disposable incomes. The younger generation increasingly prefers college over factory work, which reflects increased awareness of education and the opportunities it affords. Apart from fueling labor costs, this trend is likely to enhance the youngsters’ living standards and likely increase the demand for specialty apparel.

While Chinese apparel market looks promising on the outside, there are several challenges that can prevent American Eagle from taking advantage of the huge market potential. The market is highly competitive and consumers are extremely discerning with different needs and demands among different demographics. The recent pullback in the region’s consumer spending has discouraged retailers from expanding aggressively as it can easily lead to weak sales and inventory hangover. Apart from this, high operating costs in tier 1 & 2 cities and the dominance of low-cost local players in tier 3 & 4 cities is likely to create some roadblocks for the retailer’s expansion. ^[2] Nevertheless, since China is the biggest apparel market outside the U.S., this is the place for American Eagle to be.

The Philippines

Despite its small size, the Philippines apparel market offers good potential for value-focused retailers due to its flourishing middle class, which is benefiting from rising disposable income on account of booming BPO (Business process outsourcing) industry and increasing remittances. The Philippines is one of the biggest BPO markets in the world, with over 640,000 (2011) employees working in various call centers. ^[4] In 2013, this industry generated $13.34 billion in revenues, which was an increase of almost 15% over the prior-year level. The country’s central bank expects the BPO industry to render $15.34 billion in 2014 with a sustained growth rate of 15%. By 2016, the industry is expected to touch $25 billion in revenues with close to 1.3 million employees, suggesting better lifestyle and higher demand for branded apparel in the future. ^[5]

Apart from the booming BPO industry, substantial rise in remittances (money received from friends and relatives working abroad) is also stimulating consumer spending in the Philippines. Remittances account for close to 10% of the country’s GDP and have been rising rapidly over the past couple of years. The Philippines received $21.3 billion in cash remittances in 2012, which was 6.3 % higher than what it received in 2011. ^[6] In 2013, the figure further rose by 6.4% to $22.76 billion. Growing revenues from BPO and remittances resulted in better-than-expected economic growth of 7.2% in 2013 and a strong forecast of 6.5%-7.5% for 2014. ^[7] Therefore, we expect consumer spending to continue to improve in the coming years, which bodes well for the region’s apparel industry. Euromonitor expects the apparel market’s growth to pick up in the future driven by improving lifestyle and healthy economic growth. ^[8]

Within the apparel market, consumers have shown a preference for  high fashion low-priced brands, which has allowed them to shop more frequently. They have been increasingly switching to online shopping, which is at a nascent stage currently, but is expected to become a key distribution channel in the future. American Eagle stores in the Philippines are operated by Suyen Corporation, which is the leading apparel retailer in the country. This provides the retailer a competitive advantage over other foreign retailers entering the country. Also, Suyen Corporation invests a substantial amount on advertising and marketing, which makes it easy for American Eagle to spread its brand awareness. ^[8]

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1. B2C Ecommerce Sales Climbs Worldwide, as Emerging Markets Drive Higher Sales, eMarketer, Jun 27 2013 [↩]
2. Winning in China’s Apparel Market, AT Kearney [↩] [↩]
3. China’s bid to provide care systems for elderly faces hurdles, warn experts, South China Morning Post, Sept 4 2013 [↩]
4. BPO firms unfazed by Obama ‘job bill’, Business Mirror, Nov 8 2012  [↩]
5. BPOs made $13.34B in 2013 export services, Business Mirror, Jan 3 2014 [↩]
6. 2012 remittances hit record high, Philstar, Feb 15 2013 [↩]
7. Remittances up 6.4% to $22.76 B in ’13, Philstar, Feb 18 2014 [↩]
8. Apparel in the Philippines, Euromonitor, Jul 2013 [↩] [↩]