American Eagle Recovers from the Inventory Blues

Teen specialty retailer American Eagle Outfitters (NYSE:AEO) reported earnings March 7th, posting a net sales increase of 14% to $1.04 billion, compared to $916 million last year. ((American Eagle reports Q4 results, Source: American Eagle’s IR)) Additionally, the company also reported a comparable store sales increase of 10%, versus a 7% decrease last year. A quick scan of the stock’s recent performance easily establishes that the company has been on a roll after its Q4 results, with its stock price increasing by nearly 15% since March 7.

While the above stated factors did contribute somewhat in the hike, we believe the reduction in the inventory level from $571 million in Q3 to $378 million in Q4 was the primary catalyst behind this growth. A massive inventory level was the biggest concern for American Eagle in recent quarters, and the near 35% inventory reduction in Q4 will help its future growth. American Eagle competes with other teen specialty retailers such as  Abercrombie & Fitch (NYSE:ANF), Aeropostale (NYSE:ARO) and Gap Inc. (NYSE:GPS).

See our full analysis for American Eagle Outfitters

Inventory Hangover Was a Constant Problem for American Eagle

Inventory management proved to be the biggest challenge for American Eagle throughout 2011. While the company managed to post strong net sales and comp sales increases in its 2011 quarterly results, it failed to realize benefits from its top-line growth due to inventory hangover.

The primary reason behind this drab performance was the concern that the rising inventory could mean that American Eagle’s merchandise may not be in sync with customer expectations, just like its major competitor Aeropostale.

However, the biggest jolt from inventory hangover came during the 2011 holiday season. Starting its holiday campaign with a 40% increase in inventory levels, American Eagle was forced to churn out massive promotions on its merchandise at the end of the holidays since it was left with higher than desired inventory. This in turn took a toll on American Eagle’s margins, forcing the company to trim its Q4 earnings outlook from $0.40 – $0.44 per diluted share to $0.33 – $0.35 per diluted share.

See our article: American Eagle Cuts Q4 Earnings Outlook, Sends Shares Crashing

Inventory Reduction To Benefit American Eagle Going Ahead

A 35% reduction in inventory levels is expected to benefit American Eagle in the long term. First and foremost, the company looks all set to benefit from declining cotton prices by the second half of 2012.  An inventory hangover in Q4 2011 would have stretched the margin woes through the spring season too. This combined with a promising sales trend in February 2012 and continually improving domestic economy should set the tone for a successful Q1 2012, going ahead.

We are currently in the process of revising our $17.75 price estimate for American Eagle Outfitters, which is at a premium of 6% to its current market price.

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