American Eagle Outfitters Looks Sturdy Despite Weak Results And Dull Guidance

American Eagle Outfitters‘ (NYSE:AEO) struggle continued in Q3 fiscal 2013 as its earnings fell by more than 50% on account of weak sales and heavy promotions. The retailer’s comparable store sales declined by 5% and its gross margins shrunk to 34.9% from 41.9% a year ago. Although good expense management allowed American Eagle to attain above-guidance EPS of $0.19, it offered disappointing guidance for the fourth quarter in anticipation of a weak holiday season. ^[1] Following the earnings release, the company’s shares fell by almost 7%, bringing the overall decline since the start of the year to 20%.

However, we still maintain an optimistic outlook for American Eagle as it is capable of performing much better in the future. The retailer is enhancing its focus on fashion offerings that have performed reasonably well so far. Its direct-to-consumer channel recorded healthy growth during the quarter, which is likely to continue in the future backed by industry growth and the retailer’s efforts. Additionally, American Eagle’s factory channel continues to please with its performance, and holds good potential for the company’s long term growth.

Our price estimate for American Eagle Outfitters stands at $19, implying a premium of about 30% to the market price.

See our complete analysis for American Eagle Outfitters

More Focus On Fashion Offerings

While American Eagle’s core product sales remained soft during the third quarter, its fashion assortments found good acceptance among customers. Moreover, they have been performing well for some time now and it only makes sense for the company to expand this category. American Eagle recently hired Chad Kessler as new chief merchandising and design officer. ^[1] Chad had previously worked with Urban Outfitters (NASDAQ:URBN), which is known for its trendy products and has a history of successfully understanding its customers’ tastes. We believe that Mr. Kessler can leverage that experience and expertise to boost American Eagle’s merchandise as well.

Additionally, the retailer is working on improving its speed-to-market to enhance its ability to quickly respond to changing fashion trends. The management stated that fashion assortments hold a small percentage in its overall merchandise mix at the moment, and it is looking to increase this proportion to a meaningful level. ^[1] Given that U.S. buyers have shown a great affinity towards the brands that provide the latest fashion, this appears to be a valuable step. Increasingly fashion inventory should bring in more customers, which can have a positive impact on American Eagle’s results. However, apart from improving its fashion content, the retailer needs to keep a firm control over its prices.

Direct-To-Consumer Business Continues To Prosper

Despite the weakness in its store business, American Eagle continued performing well through its direct-to-consumer channel (mainly e-commerce). Its revenues increased by a healthy 17% during the quarter, which was much better than what its peers Abercrombie & Fitch (NYSE:ANF) and Aeropostale (NYSE:ARO) have seen in their recent results. What’s even more compelling to see is that this growth was on top of 25% increase in the same quarter last year. The company stated that its investments in omni-channel retailing are finally paying off and its new mobile app is generating robust sales. These days, a number of U.S. retailers are switching to omni-channel retailing (single view of inventory across all channels) to drive greater store and web traffic.

Going forward, as American Eagle continues to invest in its e-commerce and m-commerce channels, its direct business can become a valuable growth driver. Over the past three years, the proportion of direct-to-consumer revenues in the retailer’s net sales has increased from 11% to 13% and we expect this figure to cross 20% over the next five-six years. Apart from American Eagle’s efforts, surge in the overall online apparel industry should complement this growth. According to eMarketer, online apparel sales in the U.S. will increase to $90 billion by 2016, up from $45 billion in 2012. ^[2]

Growth Of Factory Stores Looks Promising

American Eagle’s relatively new factory channel has generated better sales than its mainline stores over the past few quarters. Despite the tough retail environment, factory stores delivered positive mid-single digits comparable store sales growth in Q3. ^[1] This, combined with the fact that there is huge room for factory stores’ expansion, gives a pleasing picture for this channel. The retailer has opened 29 factory stores so far in the year and plans another 10 for the fourth quarter and 26 for the next year. This will bring its store count of 140 by the end of 2014, which is significantly less that its mainline store count (900+). ^[1]

American Eagle’s made-for-factory products have resonated very well with its customers over the past, and it now represents almost 50% of the assortments offered in factory stores. Therefore, we believe that this channel is well equipped to be a bigger business for the company in the future.

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

1. American Eagle Outfitters’ Q3 fiscal 2013 earnings transcript, Dec 6 2013 [↩] [↩] [↩] [↩] [↩]
2. Retail Ecommerce Set To Keep A Strong Pace Through 2017, eMarketer, Apr 24 2013 [↩]