American Eagle Outfitters’ Preview: Foot Traffic Decline Can Translate Into Another Dismal Quarter

Pittsburgh-based specialty apparel retailer, American Eagle Outfitters (NYSE:AEO), is scheduled to release its Q2 fiscal 2014 earnings on August 20. The company’s performance has been below par for the past several quarters on account of its missed fashion calls and stumbling brand image, and we do not expect Q2 to be any different. The apparel retailer’s revenue per square feet fell sharply from $521 in 2012 to $469 in 2013 as U.S. consumers scaled back their spending on apparel and shunned American Eagle for fashion forward brands such as Zara and Forever 21. This trend continued in Q1 fiscal 2014 as the retailer’s comparable sales declined by a staggering 10% due to unfavorable weather and heavy promotions.

While shoppers returned to stores in the second quarter with better weather conditions, we believe that American Eagle wasn’t their primary destination. Buyers continue to avoid the brand with a perception that it is no longer cool on account of its limited fashion variety. Moreover, industry wide foot traffic continued to decline in Q2 as buyers purchased more online. Since American Eagle isn’t the most popular brand in a market where foot traffic is declining consistently, we might see an alarming decline in its store traffic and comparable sales in Q2.

However, American Eagle can leverage its omni-channel platform to slightly offset the impact of declining comparable sales. Due to the online shift, e-commerce sales across the market have improved significantly, which is good news for the company. After its tepid Q1 results, American Eagle decided to shut a total of 150 stores across the U.S. to improve its profitability. We believe that the company might have closed some of these stores in the recently concluded quarter, which can have a minor positive impact on its revenue per square feet and EBITDA (earnings before interest tax depreciation & amortization) margins.

Our price estimate for American Eagle Outfitters stands at $14.74, implying a premium of more than 35% to the market price.

See our complete analysis for American Eagle Outfitters

Falling Foot Traffic to Weigh on Results

Due to the increased proliferation of smartphones and tablets, and the convenience of online shopping, U.S. buyers have been making more purchases online. Subsequently, they are visiting fewer stores, which is a concern for a number of retailers including struggling American Eagle. As per the data compiled by ShopperTrak, a firm that tracks store traffic in over 40,000 outlets across the U.S., store visits have fallen consistently by close to 5% year over year in all the months of the past two years, barring April 2014. This is impacting sales at American Eagle, which earns close to 88% of its revenues from store sales. ((Gap, L Brands Drive July Retail Sales, The Wall Street Journal, Aug 7 2014))

Even if we consider the industry-wide fall in foot traffic as a proxy for traffic decline at American Eagle, we get a minimum of 5% store traffic decline in the second quarter. However, American Eagle has its own problems when it comes to attracting customers, and hence there is a possibility that its traffic decline in Q2 was much worse than 5%. Although the company is trying hard to revamp its brand image with several resolute efforts, it cannot change customer perception within a single quarter.

Online Growth with Omni-Channel Efforts can Provide Some Help

Over the last two years, while store traffic has declined 5% year over year in every month, except April 2014, online sales have grown 15% year over year in every quarter. ^[1] Retailers with strong omni-channel portfolios have leveraged this growth to enhance their store sales. American Eagle’s own omni-channel efforts have yielded good results so far and they might have helped the company in the second quarter as well.

American Eagle’s ship from store pilot program has helped it attract those customers, who could have shied away from the retailer if the inventory pool wasn’t integrated across all the channels. American Eagle has added this service to almost 100 of its stores and it recently opened a new fulfillment center, that is expected to enhance its capacity and reduce delivery time. While these efforts are well directed, their magnitude is small as compared to the company’s size. Nevertheless, they will have some positive impact on its comparable store sales in Q2 and pave the way for its future omni-channel development.

Store Consolidation can Have a Minute Impact

Following its weak Q1 fiscal 2014 results, American Eagle laid out plans to close 150 of its stores in the next three years out of its 300 stores whose lease will expire by 2017. In Q1 alone, the retailer shut six American Eagle and 14 Aerie stores and plans to close another 70 (50 AE and 20 Aerie) stores by the year end. The company may well have closed some stores in the second quarter, which can have a small positive impact on its overall profitability.

American Eagle’s vast network of close to 900 mainline stores and 140 Aerie stores 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 revenue per square feet 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.

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1. Shoppers Are Fleeing Physical Stores, The Wall Street Journal, Aug 5 2014 [↩]