American Eagle Outfitters’ Pre-Earnings: Weak Spending And High Promotions Will Weigh On Results

Teen apparel retailer American Eagle Outfitters (NYSE:AEO) has performed reasonably well during the past two years due to its strong inventory control & supply chain, balanced pricing strategy and e-commerce growth. However, things changed in the last quarter as prolonged cold in the U.S. subdued the demand for spring clothing and payroll tax increase weighed on the consumer spending. As a result, the company’s comparable store sales declined by 4%. ^[1]

American Eagle recently revised its estimates for the second quarter and will now report a comparable store sales decline of 7% in the upcoming Q2 fiscal 2013 earnings release on August 21. ^[2] The retailer’s margins are also expected to decline as it ushered large promotions in July to clear its inventory. ^[2] Although the company worked aggressively on its product mix for the spring and summer seasons, the demand remained low. This weakness was not exclusive to American Eagle, but encompassed the entire industry resulting from a relatively cold spring season (March-May), higher unemployment rate and a disappointing start to the back-to-school season (July). Nevertheless, the retailer’s direct-to-consumer sales growth remained strong. ^[2]

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What American Eagle Did During The Second Quarter?

American Eagle has historically leveraged its strong supply chain to launch new and trendy products in a timely manner. This continued in Q2 fiscal 2013 as the retailer launched its spring collection featuring bright colored pallets such as indigo washed navy, lifeguard red, nautical yellow and sailcloth white, inspired by vintage nautical flags of World War II. ^[3] For its women’s merchandise segment, the company introduced a wide range of trends such as ballet, barbie pink, mint, seafoam, ultra feminine lilacs and lavender. It combined these trends with a variety of fabrics and silhouettes to develop appealing apparel. ^[3]

For its summer collection, American Eagle introduced mixes of eye catching bright colors along with high quality fabrics for its conventional products such as jeans, t-shirts, shirts and shorts. ^[4] It also launched some preppy offerings such as printed board shorts, chambray shirts, along with other products featuring mohawk prints, dip-dyed styles, tropical floral, Aztec prints and crochet textures. ^[5] While the merchandise offerings were strong, weather had a significant impact on the sales.

Industry Wide Apparel Sales Remained Weak

The spring season in the U.S. this year was evidently the coldest since 1996 with average temperatures around 50.5 degree Fahrenheit. Moreover, the season also turned out very wet with average precipitation 0.21 inch above the 20th century average. ^[6] These weather conditions resulted in low demand for clothing that suited warmer and drier climate, which impacted the industry wide apparel sales during the period of May-March. Additionally, the consumer spending remained weak during the quarter due to high unemployment rate as the U.S. employers slowed their hiring pace outside the farming sector. ^[7] The worst affected was the teenage segment where the unemployment rate rose to 23.7% in July. ^[8]

As a result, the beginning of the back-to-school season (July), which is the second most important season for apparel retailers, was quite weak. According to the National Retail Federation, average spending per family on apparel, shoes, supplies and electronics will decline by almost 8% during this season compared to 2012. ^[9] This can be attributed to last year’s record back-to-school season spending and cautious consumer spending this year on the account of payroll tax increase. Overall, the second quarter was disappointing for a number of retailers including Aeropostale (NYSE:ARO) and American Eagle Outfitters.

Large Promotions To Impact Margins

The apparel industry witnessed heavy markdowns in July with a number of retailers looking to end the quarter with low inventory carryover. Gap Inc (NYSE:GPS), which is one of the strongest apparel retailers in the U.S., saw its July comparable store sales increase by just 1% due to high promotional activities. ^[10] American Eagle followed a similar strategy as weak sales during the first two months of the quarter resulted in a large pool of inventory. The impact was more profound in the retailer’s women’s merchandise assortments, which accounts for more than half of its revenues. ^[2] As a result, American Eagle undertook broader and deeper set of promotions to clear its inventory. Although this enabled it to achieve a better inventory position moving into the third quarter, it weighed on the comparable store sales growth and margins.

Our price estimate for Target stands at $27, implying a significant premium to the market price. However, we’ll revise our price estimate post earnings.

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

1. American Eagle Outfitters’ SEC filings [↩]
2. American Eagle Outfitters Revises Second Quarter Outlook, American Eagle Outfitters, Aug 5 2013 [↩] [↩] [↩] [↩]
3. Spring 2013 Designer Inspiration, American Eagle Outfitters, Jan 18 2013 [↩] [↩]
4. Spring-Summer Collection 2013 By American Eagle Outfitters, Fashion Hunt World [↩]
5. Cool dudes troop with their gals to American Eagle Outfitters, PhilStar, Jun 16 2013 [↩]
6. Spring 2013 Recap: Cool temperatures dominate the U.S., Climate.gov, Jun 12 2013 [↩]
7. Retailers boost July sales with heavy discounts, promotions, Reuters, Aug 8 2013 [↩]
8. Teen Retailers Could Be In for Rough Back-To-School Season, The Wall Street Journal, Aug 6 2013 [↩]
9. On heels of historically high back-to-school season, 2013 spending expectations decline, National Retail Federation, Jul 18 2013 [↩]
10. Gap Inc. Reports Second Quarter And July Sales Results, Gap Inc., Aug 8 2013 [↩]