American Eagle Outfitters’ Revenue Per Square Feet Can Recover With Better Fashion And Fewer Underperforming Stores

American Eagle Outfitters‘ (NYSE:AEO) mainline brand revenue per square feet (RPSF) improved consistently from $434 in 2009 to $521 in 2012, as disciplined inventory control and a balanced pricing strategy helped it deliver trendy and affordable merchandise that resonated well with customers. In addition, the retailer’s 360 degree marketing strategy and loyalty rewards programs bolstered its brand image in the U.S., building a strong and  loyal customer base. However, in 2013, the company’s RPSF crashed to $469, as U.S. buyers shunned American Eagle for fashion-forward brands such as Zara & Forever 21. American Eagle was unable to attract customers, due to its perseverance with basic products and off-pitch fashion calls. Adding to the retailer’s problems, the entire U.S. apparel industry struggled last year due to weak consumer confidence and changing spending patterns.

We expect American Eagle’s RPSF to remain flat this year, and gradually improve thereafter driven by better fashion, improving brand image and store consolidation. American Eagle’s fashion category has done well so far, but it has been unable to boost the retailer’s results due to its infinitesimal contribution. Since the company is aggressively working on increasing the proportion of fashion category in its portfolio, it can have a visible impact in coming years. Lately, many buyers have developed a perception that American Eagle brand is not “cool”. The company is trying hard to turnaround its brand image before the perception becomes too entrenched. In its recent quarterly results, American Eagle unveiled plans to close 150 underperforming stores in the next few years. By closing stores that do not account for significant traffic, American Eagle will be able to improve its store productivity.

Our price estimate for American Eagle Outfitters stands at $14.74, implying a premium of close to 30% to the market price.

See our complete analysis for American Eagle Outfitters

Efforts To Mend Brand Image & Improve Fashion Can Drive RPSF

Over the past year, American Eagle has seen its brand falter in the U.S., burdened by its overemphasis on basic products, missed fashion calls and a limited fashion variety. As a result, trend conscious teenage buyers have developed a perception that American Eagle brand isn’t “cool” anymore. However, the company is working very hard to rejuvenate its brand image by specifically focusing on product design and marketing. Despite its weak connection with customers, some of American Eagle’s products, such as denim, still remain very popular. A while back, music icon Shakira wore American Eagle jeans in Women’s Health magazine, which somewhat defines its popularity. The company can leverage such instances to promote its products aggressively. To engage customers in an appealing manner, American Eagle has organized certain marketing events such as AE Real People and Aerie’s Real campaign. Also, the company has leveraged its rewards program to encourage customers to visit American Eagle stores frequently. We expect the company to come up with more events and offers aimed at increasing the brand visibility, which can have some positive impact on its brand image going forward. Subsequently, American Eagle will be in a better position to drive store traffic and boost RPSF.

Apart from energizing its brand image, American Eagle is looking to strengthen its product assortments with more innovation in distinct finishes, fabrics and washes. The inclusion of Chad Kessler (chief merchandising and design officer hired last year) in the designing system is expected to bring some fresh and relevant changes to the brand’s merchandise. During the recently concluded quarter, the retailer saw heavy demand for certain categories, such as heritage bottom denims and pants, and fashion capsules. Their demand was driven by adoption of new styles, which is a pleasing sign for the company. Going forward, American Eagle is planning to simplify its designing system to respond to changing customer tastes quickly and effectively. It is removing layers within its designing teams, reorganizing the structure to implement direct accountability and enhancing its speed sourcing capabilities. One such development on this front is the retailer’s fast-track fashion capsules, whose designing to in-store receiving process takes just 60 days. Also, American Eagle is looking to enhance its focus on accessories and outerwear, which were de-emphasized last year. By effectively leveraging these factors, the company will be able to increase the proportion of fashion products in its portfolio, which will complement its RPSF growth.

Store Consolidation Will Help Productivity

American Eagle operates a vast network of over 900 mainline stores in the U.S. While such presence enables the company to encompass a large customer demographic, it also increases the chances of self-cannibalization. There also exists a possibility that the retailer operates certain stores in regions where foot fall is significantly lower than what the stores can handle. Under such situations, stores do not operate at their full capacity, which results in low RPSF and higher SG&A expenses. Since American Eagle is already struggling to attract customers due to low brand loyalty, it is planning to close under-performing stores to offset the impact of low store traffic.

In its recent earnings call, American Eagle’s management stated that it closed six mainline stores during Q1 and will close another 50 in 2014 upon lease expiration. Overall, the company has identified 150 stores to close in the next three years out of its 300 stores whose lease will expire by 2017. ^[1] Closing stores that do not generate sufficient revenues will help American Eagle improve its RPSF.

How Significant Is This Metric?

We currently forecast American Eagle’s mainline store RPSF to gradually increase from $469 in 2013 to $546 over the next five to six years. However, if the retailer’s problems persist for a longer-than-anticipated duration, restricting the RPSF growth to $500, there can be more than 5% downside to our price estimate for the company. On the contrary, if its efforts to boost store traffic and revitalize brand image bring customers back, driving RPSF to $580, there can be about 5% upside to American Eagle’s price estimate. Given that the company hasn’t started well in 2014, the downside scenario appears more plausible.

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1. American Eagle Outfitters’ Q1 fiscal 2014 earnings transcript, May 21 2014 [↩]