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

In our previous note “Factors Supporting Our Bullish Outlook For American Eagle Outfitters – Part I,” we discussed American Eagle Outfitters‘ (NYSE:AEO) efforts to expand its fashion offerings, its strong direct-to-consumer channel and its growing factory store network. We’ll continue our analysis of the company in this note with a focus on the retailer’s international expansion plans and the growth of its intimates brand Aerie.

American Eagle has been exploring opportunities to expand in foreign markets to add new revenue streams to its business and reduce its dependence on the highly saturated U.S. market. With continued expansion, we believe that the retailer’s business will have more balance and resilience in the future. Although American Eagle’s intimates brand Aerie is still small, it has shown some promising signs. As the company expands this brand in the future, it will be better positioned to boost the retailer’s results.

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

International Expansion

Currently, American Eagle’s international presence is limited to 50 franchise stores in 13 countries, but it is looking to speed up its expansion by targeting the most lucrative markets. Early last year, the company assumed control over its six franchise stores in China and appointed Kitty Yung as the president of its Asia-Pacific operations. Given China’s growing urbanization and rising disposable income, its apparel market is expected to touch $220 billion in 2016, up from $140 billion in 2012. ^[1] Moreover, online retail sales in the region are expected to increase from $110 billion in 2012 to $440 billion in 2016. ^[2] Therefore, it makes sense for the company to have a firm focus on China. Also, hiring Kitty Yung should complement American Eagle’s growth as she had previously helped Guess‘ (NYSE:GES) operations in the region to grow over 200 stores, resulting in an average annual revenue growth of 25% during 2010-2012.

American Eagle also announced the opening of its first store in Mexico last year, where a young customer base, rising disposable income and increasing fashion consciousness can help it succeed. The brand is already known in the region due to the launch of its Mexico-specific e-commerce website in 2012, and therefore it may not have to struggle much as far as brand advertising is concerned. Additionally, American Eagle entered the Philippines last year and recently announced its plans to enter Thailand. Though small in size, both these markets are in the growth phase with consumers who spend to improve their lifestyle.

The apparel market in the U.S. is highly saturated and competitive with a large number of established brands. Moreover, the sluggish economic growth has been a big worry for the entire industry. This year in particular, apparel retailers have struggled to achieve positive growth as cautious consumer spending and change in spending patterns have weighed on sales. Moreover, teen buyers have been readily changing brands based on the trendiness of their fashion, which has troubled a number of players. Along with several other retailers, American Eagle has been at the receiving end of this trend. Its comparable stores sales have declined by 5%, 7% and 4% respectively during the last three quarters, and the holiday season might have been the same. Given the situation in the U.S., exploring opportunities in international markets is warranted. It will not only open new revenue channels for the company, but will also help diversify the business risk geographically. With slightly better macroeconomic conditions and lesser competition, international markets might provide American Eagle with the opportunity to operate more full priced sales. This should help the company generate better cash flows, which will ultimately have a positive impact on its stock price.

Significant Growth Potential For Aerie

American Eagle’s Aerie mainly caters to teenagers and young females who are fashion conscious and are likely to spend on intimate products. About 15% of the total female population in the U.S. are between ages 15 and 24. ^[3] The overall lingerie market in the U.S. stands at over $12 billion, and is currently dominated by only a few established brands. ^[4] American Eagle launched Aerie back in 2006 and currently operates around 150 stores across the country. In comparison, Victoria’s Secret has more than 1,000 stores. Moreover, Victoria’s Secret’s new brand PINK, which primarily targets college girls, has been extremely successful and Limited brands (NYSE:LTD) has scaled up its expansion in this area as well. Hence, we believe that there is a huge potential for Aerie’s aggressive expansion in this market. Although American Eagle has expanded its lingerie brand slowly over the past few years, the comparable store sales growth has been impressive (6% in 2012). We believe that the company has the opportunity to ramp up Aerie’s expansion by opening new stores, and creating shop-in-shop locations within its American Eagle stores to increase the brand’s reach.

The encouraging trend is that U.S. buyers have continued to spend on intimate products even during the sluggish economic environment. During the last couple of quarters, Victoria’s Secret registered robust growth for its intimate products, even though the apparel industry remained weak overall. Even Aerie’s performed better than American Eagle’s namesake brand during Q2 and Q3 fiscal 2013.

With the right push, we believe that Aerie can follow in the footsteps of Victoria’s Secret. The brand can fend off the fierce competition in the intimates market as its products are affordable and more about usability than glamor. We think that given the macroeconomic conditions, young U.S. shoppers are likely to find a balance between fashion and value, and that might work in Aerie’s favor. Hence, we believe that the brand holds good promise for American Eagle from long term perspective.

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

1. China’s apparel retail market: $218 industry by 2016, Trans World News, Aug 3 2013 [↩]
2. B2C Ecommerce Sales Climbs Worldwide, as Emerging Markets Drive Higher Sales, eMarketer, Jun 27 2013 [↩]
3. United States Census Bureau [↩]
4. Lingerie Stores In The U.S. Market Research Report, IBIS World, May 2012 [↩]