American Eagle Outfitters’ Weak Performance Will Continue In Q3

This year, specialty apparel retailer American Eagle Outfitters (NYSE:AEO) has struggled with its growth due to a sluggish retail environment in the U.S. and weak customer response to its product offerings. During the first quarter of fiscal 2013, the retailer’s revenues and comparable store sales (CSS) slipped by 5% and 4%, respectively. This performance continued in the second quarter with 2% fall in revenues and 7% decline in CSS. Following the weak results, the company slashed its outlook for the third quarter. In line with its expectations, American Eagle reported decreases of 6% and 5%, respectively, in third-quarter revenues and CSS with its Sales Results release in early November.  It also pre-announced above-guidance EPS of 19 cents from slightly better-than-expected margins.  ((American Eagle Outfitters Updates Third Quarter EPS Guidance to $0.19, American Eagle Outfitters, Nov 6 2013)) We look forward to learning more about the upside when the company fully reports on December 6th.

It appears that cautious consumer spending and heavy promotions continue to weigh on retailers’ growth. During the last quarter, a bulk of American Eagle’s offerings were not well received by customers, a trend that may have continued, the pre-announcement notwithstanding. The retail environment in the U.S. continues to be weak, due t the impact of the weak economy on consumers. Players such Gap Inc (NYSE:GPS) and Abercrombie & Fitch (NYSE:ANF), who recently reported their results, stated that this factor had a big impact on their growth. That said, some of American Eagle’s fashion offerings have been well received by its customers in the past. During the earnings release, we will learn what combination of factors led to better-than-expected margins in this weak environment.

Our price estimate for American Eagle Outfitters stands at $20, implying a premium of about 30% to the market price.

See our complete analysis for American Eagle Outfitters

Low Consumer Spending On Apparel Weighs On American Eagle’s Growth

Pressured by slow job growth, increased taxes, higher healthcare costs and gasoline prices, U.S. buyers have scaled back their discretionary spending this year. A percentage of consumers have started diverting their spending to cars and houses to take advantage of the low interest rates. As a result, consumer spending on apparel products has been sluggish so far in the year. In response to this weakness, U.S. retailers have ushered heavy promotions to win back customers and lower inventory. Due to heavy markdowns, American Eagle’s counterpart Abercrombie & Fitch reported a decline of 14% in its Q3 comparable store sales. Admitedly, A&F has issues of its own.  Still, we believe that this factor contributed to the company’s 5% CSS decline during the third quarter.

Weak Response To Core Offerings Might Also Have An Impact

Despite the prevailing weakness in the U.S. apparel industry, a retailer can prosper  if its products are in line with customers’ wants. This is evident from the fact that retailers such as Gap Inc , Urban Outfitters (NASDAQ:URBN) and Ann (NYSE:ANN) have managed to register positive growth with a quick fashion turnaround. However, American Eagle has been unable to do so to date. In the last quarter, the retailer’s women’s collection failed to generate sufficient demand.   American Eagle felt that these products were still mis-positioned versus the relevant trends and innovations driving shopper interest. ^[1]

Although the company is looking to re-assort its product mix, it will have had difficulty producing a turnaround in value, trend, relevancy and innovation within a single quarter. We look forward to a progress report and are eager to seeing both what American Eagle is doing to revamp this category and how customers are responding to the changes.

Fashion Category Is Promising But Not Big Enough To Drive Results

While American Eagle’s women’s business remained weak for the most part in Q2, its fashion offerings performed reasonably well. Fashion styles in pants and tops were among the best performers. The retailer’s men’s products found better acceptance compared to its women’s merchandise, driven by the addition of relevant trends in men’s pants, tops, polos and graphics. Following the results, the retailer planned to continue to promote its better performing products and re-assort its offerings for Q3 and Q4, with new styles and compelling fashion at good value. Therefore, we expect this category to continue to do well. The company has a history of being responsive to fashion changes and its supply chain has supported it well. With strong discipline in inventory management, the retailer is unveiling new designs on a monthly basis with a focus on shopping patterns and holidays.

Although these fashion offerings have been well received by its customers, they account for just 30% of its overall products. Therefore, this category is not big enough to have a large impact on the company’s results. We will monitor their performance during the third quarter, as this category is quite essential for American Eagle from a long term perspective.

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1. American Eagle Outfitters’ Q2 fiscal 2013 earnings transcript, Aug 21 2013 [↩]