What Justifies American Eagle Outfitters’ 25% Upside?

American Eagle Outfitters (NYSE:AEO) is one of the popular apparel retailers in the U.S. offering high quality and trendy fashion clothing at affordable prices for men and women. The company’s stock price has increased by almost 25% over the last year driven by its strong financial performance which can be attributed to store consolidation, quick response to changing fashion and rapid growth in direct-to-consumer business. Apart from these trends, international expansion, better inventory control and improved customer engagement are some other factors that justify our premium over the market price. In this analysis we’ll briefly discuss these factors.

See our complete analysis for American Eagle Outfitters

Growth In Direct-To-Consumer Channel

The apparel industry in the U.S. is being driven by consistent growth in the direct-to-consumer channel. Historically, players such as Urban Outfitters (NASDAQ:URBN), Abercrombie & Fitch (NYSE:ANF) and Gap (NYSE:GPS) have seen substantial growth in this business. Even American Eagle Outfitters’ own direct revenues increased at an average annual rate of 10% during 2009-2010. Although the growth has been slower than that of its peers, it picked up in 2012 amounting to 21%.

Going forward, we expect this trend to continue, further complemented by the new distribution center and efforts to create a platform for omni-channel capabilities. To achieve this, the retailer will be implementing a new global enterprise system, which will integrate its point-of-sale system and merchandise system. ^[1] Omni-channel retailing enables the retailer to provide seamless customer experience across its channels. We believe that at some point of time, American Eagle Outfitters will integrate its inventory pool across its stores and distribution centers. This approach has worked for retailers such as Urban Outfitters and Ann (NYSE:ANN) as it allows them to improve delivery responsiveness.

International Expansion

Until a few years back, American Eagle Outfitters’ operations were confined to the U.S. which made the retailer more susceptible to the economic downturn. In 2009, revenue per square foot for the retailer’s branded stores reduced by more than 3% and in 2010, its direct channel witnessed a similar decline. International markets with better economic conditions and lower competition than the U.S. can provide better revenue growth and margins.

During the last four years, American Eagle Outfitters has energized its international expansion and currently has about 45 franchisee stores in 11 countries. It recently opened its first franchisee store in the Philippines and will assume control of its licensee stores in China. The retailer plans to continue expanding in these regions throughout 2013. ^{[2] [3]} Furthermore, American Eagle Outfitters has plans of opening about six stores in Mexico in 2013 and many more in the coming years. ^[4] This positions it well for future growth. We believe that it’s only a matter of time before the retailer expands its store network in international markets.

Better Inventory Control And Customer Interaction

With better control over its inventory, American Eagle Outfitters is able to launch new fashion and operate with fewer discounts. In Q4 fiscal 2012, the retailer reduced the total merchandise inventory by 10%, which helped its results. ^[5] Management has stated that it is looking to reduce the lead time by a few weeks to a few months. ^[1] This should make it more responsive to changing fashion and customer needs and maintain tighter inventory. We believe that going forward this will help the retailer’s comparable store sales growth.

American Eagle Outfitters employs a number of strategies to attract customers and provide them with the best deals. The retailer uses a 360-degree marketing approach encompassing the social media channel, TV commercials and mobile advertisements. ^[6] Moreover, it is looking to add more product variety at opening-priced, mid-priced and high-priced tiers. ^[6] Striking a balance between these will help the retailer attract customers from different demographics.

American Eagle Outfitters’ reward program aims at increasing store traffic. This program allows customers to earn one reward point per dollar spent at the store or e-commerce website. These points are totaled every three months after which the customers become eligible for discounts. ^[7] Additionally, they are offered a 15% discount on purchases made during their birthday months. Last year, the retailer witnessed a 36% increase in new customer signups for the program. ^[1] Keeping customers interested is the basic rule of retailing and American Eagle Outfitters appears to be doing the right things to achieve this.

Our price estimate for American Eagle Outfitters stands at $25, implying a premium of about 20% to the market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. American Eagle Outfitters Q4 fiscal 2012 earnings transcript, Mar 6 2013 [↩] [↩] [↩]
2. American Eagle Outfitters Opens High Street Location in Philippines, American Eagle Outfitters, Mar 1 2013 [↩]
3. American Eagle Outfitters To Assume Operations of Six Existing Stores In China, American Eagle Outfitters, Feb 4 2013 [↩]
4. American Eagle Outfitters To Launch First Store in Mexico, American Eagle Outfitters, Jan 28 2013 [↩]
5. American Eagle Outfitters Reports Record Annual sales of $3.5 billion and 43% growth in adjusted EPS, American Eagle Outfitters, Mar 6 2013 [↩]
6. American Eagle Outfitters’ Q2 fiscal 2012 earnings transcript, Aug 22 2012 [↩] [↩]
7. American Eagle Outfitters’ Reward [↩]