Factors Supporting Our Bullish Outlook For American Eagle Outfitters – Part I

U.S. apparel retailer, American Eagle Outfitters (NYSE:AEO), has not been the best performer over the past one year, mainly due to its missed fashion calls and an overall weakness in the U.S. apparel industry. The retailer has been unable to hold onto its customers lately, as competitors such as Gap Inc (NYSE:GPS), Zara, Forever 21, and others have offered better and fashion relevant products at affordable prices. Owing to its weak financial performance, American Eagle’s stock has fallen by almost 30% since March 2013.

However, we still remain bullish on the company as we believe that it is capable of improving performance in the future. American Eagle is working hard to expand its fashion category, which does not contribute much to its revenues at the moment, but has been performing well. Moreover, despite the retailer’s problems, its direct-to-consumer channel has sustained its steady growth momentum. This is likely to continue in the future as the outlook for online apparel industry in the U.S. is very bright. Also, American Eagle’s factory channel continues to perform well and holds good potential for the company’s long term growth.

Factors such as American Eagle’s international expansion and growth of its Intimates brand Aerie also support our bullish outlook, but we’ll discuss them in a separate note that will follow soon.

Our price estimate for American Eagle Outfitters stands at $18.88, implying a premium of about 25% to the market price.

See our complete analysis for American Eagle Outfitters

Greater Focus On Fashion Offerings

While American Eagle’s core products have struggled this year, its fashion assortments have found good acceptance among customers. This trend continued in the third quarter and it only makes sense for the company to expand this category. During its last quarter’s earnings call, American Eagle’s management stated that its merchandise team is focused on ensuring that 50% of its business comes from core products, 30% from core fashion and the remaining from fashion. This clearly indicates that currently fashion does not contribute much to the retailer’s revenues. However, the company is making several efforts to strengthen this category.

American Eagle recently hired Chad Kessler, who has previously worked with Urban Outfitters (NASDAQ:URBN), as the new chief merchandising and design officer. ^[1] URBN is well known for its trendy products and has a history of successfully adapting to customer tastes. Therefore, we believe that Mr. Kessler can leverage that experience and expertise to boost American Eagle’s merchandising capabilities as well. Additionally, the retailer is working on improving its speed-to-market, to enhance its ability to quickly respond to changing fashion trends. 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 will have a positive impact on American Eagle’s results. However, apart from improving its fashion content, the retailer needs to keep control of its prices. Otherwise, it might end up with Aeropostale‘s (NYSE:ARO) problems, whose fashion offerings turned out to be very expensive and failed to garner customer attention.

Continued Growth Of Direct To Consumer Business

Since 2008, American Eagle’s direct-to-consumer revenues have increased by over 50% as online shopping became more popular among U.S. buyers. This year, even as the retailer’s stores channel struggled due to the weakness in its product offerings, its e-commerce business remained resilient. In Q3 fiscal 2013, American Eagle’s comparable store sales declined by 5%, but its direct revenues surged by 17% on top of 25% growth witnessed 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, a 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]

Factory Channel Is Promising

American Eagle’s factory channel, which was launched not too long ago, has been generating better sales than the company’s mainline stores. During the most recent quarter, factory stores delivered mid-single digit, positive comparable store sales, despite the tough retail environment. Although currently this channel is not big enough to have a material impact on American Eagle’s results, the U.S. market does provide huge room for its growth. 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 to 140 by the end of 2014, which will still be significantly less that its mainline store count (900+). 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 positioned 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 [↩]