Sales To Improve, But Margins Expected To Remain Pressured For American Eagle In The Third Quarter

American Eagle Outfitters (NYSE:AEO) has been one of the standout players in the teen apparel space, and has managed to grow its revenues despite a slowdown in the industry. After a stellar second quarter, where the company delivered a tenth straight quarter of comparable sales improvement, the momentum is expected to carry on in the third quarter, with an over 2% improvement in sales. While the previous quarter marked the second consecutive quarter of a beat on revenue expectations, the company also posted an earnings beat, after a miss in the first quarter. Hence, the question on every investor’s mind is whether AEO will top the estimates this time around as well. This sales rise is anticipated to be driven by an upsurge in its online channel, which has been doing tremendously for the company. However, a focus on this space, as well as an excessively promotional environment, is expected to pressure the margins, resulting in a fall in the earnings, as compared to the prior-year quarter.

E-Commerce Business To Continue Its Strong Performance

American Eagle delivered a tenth straight quarter of double-digit gains in its online sales in the second quarter, which represented 23% of the total revenue. Given the robust performance of this business, the company has focused its marketing on the digital space, which should be highly effective in drawing in new customers. Moreover, to reel in these customers, AEO has also launched a new rewards program in the third quarter, which should ensure growth in the future as well. AE jeans also represent another avenue for long-term success, with the company growing to be the number two retailer in America across all demographics.

The Aerie brand is another strong contributor to the growth the company has seen recently. In the second quarter, it achieved 26% comps improvement, building on the 24% seen in the prior-year quarter. This figure is all the more impressive when compared to the growth figures delivered by its competitors. While the brand is much smaller in terms of sales when contrasted with Victoria’s Secret, the latter posted a comps decline of 14% in Q2. New product lines such as swimwear, including Chill.Play.Move, besides its lingerie segment, can be expected to drive growth in the third quarter. The successful marketing campaigns run by the brand resonate well with the consumers, making it poised to carry on its tremendous performance in the future. This division of the company has also benefited from the immense growth of the online business, which represented 40% of the sales posted by Aerie in the second quarter.

Excessive Promotions To Strain Margins

While the top-line growth delivered has been impressive given the soft state of the apparel retail market in the country, it may have been driven by the promotions put in place by AEO. This factor has strained the margins, with a 260 basis points decline witnessed in the gross margins in Q2. While unfavorable weather conditions were blamed for the rise in promotions, the sales trends were better than the first quarter, with positive traffic, more transactions, and a higher average unit retail price in the second quarter. A greater focus on the online space, reflected by a higher digital marketing spending, can be expected to push up the SG&A expenses, which coupled with the higher promotions, can strain the operating margin in the third quarter. AEO has also guided for lower merchandise margins in the quarter due to an increased level of promotions, as well as a low-single-digit rise in SG&A dollars, as compared to last year.

We have a $13 price estimate for American Eagle’s stock, which is below the current market price.

See our complete analysis for American Eagle Outfitters

Have more questions about American Eagle Outfitters? See the links below:

• Is India The Place To Be For Apparel Retail Companies?
• American Eagle: Winning In The Teen Apparel Space
• Apparel Retail Companies: Surviving The Holidays 101

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