China Offers Upside Potential For American Eagle Outfitters

A few months ago, American Eagle Outfitters (NYSE:AEO) terminated its licensing agreement in China and Hong Kong to assume control over the existing stores. ^[1] With this decision, the retailer appears to be following in the footsteps of peers Gap (NYSE:GPS) and Abercrombie & Fitch (NYSE:ANF) in the world’s second largest apparel market.

Recently American Eagle Outfitters appointed Kitty Yung as the president of Asia Pacific operations. Yung had previously played an important part in Guess‘ (NYSE:GES) growth in the region. ^[2] Given the market’s potential and strong growth fundamentals, we believe that American Eagle Outfitters can do well in China. If the expansion in these markets progresses better than we currently expect, we could see an additional 5-10% upside to our forecasts.

See our complete analysis for American Eagle Outfitters

What China has To Offer?

Over the past few years, China has seen robust economic growth. Even when the global economy was reeling under the impact of the recession in 2008-2009, the country was able to sustain growth with rising income levels and increasing urbanization. ^[3] The substantial rise in the region’s labor costs has been one of the primary reasons behind the increase in disposable income. At the end of 2012, about 53% of Chinese resided in urban areas, which was significantly lower than the proportion of urban population in the U.S. and Japan. ^[4] This indicates there is a huge scope of urbanization and this figure could reach 65% by 2025. ^[5]

These factors have resulted in rapid growth in China’s apparel industry. Prior to 2011, the region’s apparel sales were growing at an average annual rate of about 16%. ^[6] In 2009, the market stood at $110 billion and consulting firm McKinsey expects this figure to cross $200 billion by 2014. ^[6] On the other hand, growth in the U.S. apparel industry has been slow. This is why several U.S. apparel retailers such as Gap are aggressively expanding in China.

The Retailer’s Growth Fundamentals And New Management Will Help

Disciplined Inventory Control: A timely launch of new fashion & seasonal collection is critical to any apparel retailer’s success. A retailer can ensure this by maintaining optimum inventory levels and lead times. American Eagle Outfitters is strong on this front as it has managed its inventory well. In Q4 fiscal 2012, the retailer reduced its total merchandise inventory by 10%, which boosted its results. ^[7] Moreover, the company’s management stated that it is looking to reduce lead time by a few weeks to a few months. ^[8] We believe these factors will help American Eagle Outfitters in China as well.

Marketing & Pricing Strategies: The company 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. Moreover, it is adding more product variety at opening-priced, mid-priced and high-priced tiers. Striking a balance between these will help the retailer attract customers from different demographics. Pricing could especially be critical in China where buyers are likely to be more value-conscious compared to developed markets such as the U.S. and Europe.

Customer Engagement Through Rewards Program: 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 online. These points are totaled every three months after which the customers become eligible for discounts. ^[9] Additionally, they are offered a 15% discount on purchases made during their birthday months. Last year, the retailer witnessed 36% growth in new customer signups for the program. ^[8]

Omni Channel Retailing: This refers to a seamless shopping experience through all the available channels such as physical stores, mobile, internet, catalog, etc. Omni-channel retailing enables retailers to engage customers irrespective of the shopping channel they prefer. ^[10] American Eagle Outfitters is implementing a new global enterprise system, which will integrate its point-of-sale system and merchandise system. ^[8] At later stages, it might look to integrate its inventory pool across stores and distribution centers to offer product variety across all channels.

However, we believe that American Eagle Outfitters will need to tailor these strategies to better appeal to the discerning Chinese buyers. This is where Kitty Yung, the newly appointed president of Asia Pacific operations, comes in. She previously worked with Guess and helped its business in China grow to over 200 stores, resulting in average annual revenue growth of about 25% over the past three years. ^[11] American Eagle Outfitters believes that Kitty Yung with her experience and development skills could play a vital role in the retailer’s growth in China. ^[2]

What’s The Significance?

We currently forecast American Eagle Outfitters’ overall store count to remain at the current levels. We believe that the store consolidation strategy could offset growth resulting from expansion in underpenetrated markets, factory stores expansion and entry into international markets. However, consider a scenario where the retailer decides to aggressively expand in China like Gap and opens about 15-20 stores annually. Assuming that these initial stores generate slightly better revenue per square feet, similar to what Gap has seen, there could be 5-10% upside to our price estimate.

Our price estimate for American Eagle Outfitters stands at $27, implying a premium of about 40% to the market price.

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

1. American Eagle Outfitters To Assume Operations Of Six Existing Stores In China and Hong Kong, American Eagle Outfitters, Feb 4 2013 [↩]
2. American Eagle Outfitters Appoints Kitty Yung To EVP/President Of Asia Pacific, American Eagle Outfitters, Apr 10 2013 [↩] [↩]
3. Apparel In China, Euromonitor, Apr 2012 [↩]
4. China’s population – Peak toil, The Economist, Jan 26 2013 [↩]
5. United Nations, Department of Economic and Social Affairs [↩]
6. From Mao to Wao: Winning in China’s Booming Apparel Industry, McKinsey, Jan 2011 [↩] [↩]
7. American Eagle Outfitters Reports Record Annual sales of $3.5 billion and 43% growth in adjusted EPS, American Eagle Outfitters, Mar 6 2013 [↩]
8. American Eagle Outfitters Q4 fiscal 2012 earnings transcript, Mar 6 2013 [↩] [↩] [↩]
9. American Eagle Outfitters’ Reward [↩]
10. Is This The Year Of Omni-Channel Retailing, Merchant Warehouse, Feb 21 2013 [↩]
11. Guess’ SEC filings [↩]