Higher Consumer Spending To Benefit American Eagle In The First Quarter

American Eagle Outfitters (NYSE:AEO) is set to post its first quarter results on May 31, wherein a rise in both revenue and earnings is expected. While its namesake segment is also expected to witness comparable sales growth, Aerie should be the standout performer, given its tremendous potential and the increased digital penetration of this segment. The earnings are projected to grow from 16 cents in the corresponding quarter of last year to 22 cents in Q1 2018 (three months ended April 2018). Higher sales, a reduced promotional environment, benefiting from improved consumer confidence, and a lower tax rate are the main factors that should drive the earnings growth.

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Factors That May Impact The Quarter’s Performance

1. Latest Thomson Reuters Same Store Sales (SSS) Index: Analysts polled by Thomson Reuters are increasingly bullish on consumer spending in the wake of strong holiday sales, which they feel has continued into the first quarter. The Thomson Reuters Same Store Sales Index has shown a stronger comparable sales growth in Q1 2018 versus Q1 2017. Besides improving consumer confidence, retailers can also be expected to benefit from easier comparisons, given a weak first quarter last year.

2. Higher Retail Sales: According to the U.S. Census Bureau, retail sales were up 4.7% in April. Categories with strong growth included clothing/clothing accessories, which rose 4.1% as compared to the previous year, a factor that should bode well for apparel retailers. Macy’s, which posted its first quarter results recently, reported strong consumer spending as a factor that resulted in the company raising its full year earnings guidance. This should put the confidence back into the retail industry. Moreover, even Urban Outfitters posted stellar earnings, which bodes well for a company like American Eagle.

3. Strength of Aerie: American Eagle’s lingerie and activewear brand, Aerie, has gone from strength to strength, driving sales growth for the company. It posted a 15th consecutive quarter of positive comps in Q4 2017, at 34%, building on the 17% seen in the prior year period. In addition to impressive growth in core intimates, the company has seen strength in apparel, active wear, and swim wear. The company expects the brand to cross $1 billion in sales in the next couple of years, with a lot of this growth coming from its digital channel, which has been growing at a tremendous rate. Looking ahead, the brand remains poised for long term growth as it continues to push through new ideas and fabrics. Moreover, since only 50% of women who shop at the AE brand are Aerie shoppers, it presents the brand with plenty of room to grow. Aerie is also expanding its store count, with 35 to 40 new stores expected in 2018.

4. Opportunity for Margin Expansion: While the gross margin continued to slide throughout 2017, as a result of the increase in promotions, higher shipping costs, and a rise in compensation, the rate of deceleration improved as the year carried on, with the 270 basis points of gross margin erosion in the first quarter reduced to 80 basis points in Q4. The company expects the sequential improvement in margins to continue in FY 2018, which implies that the gross margin in Q1 2018 could actually be higher than that in the corresponding quarter of FY 2017. This is expected to be driven by reduced discounting, and investments undertaken to improve margins in the digital space, including automation of the pick and pack processes in the distribution centers and implementation of a shipping optimization software.

5. Growth of Digital Segment: AEO reported digital sales growth of over 20% in the fourth quarter, reaching record levels, making it the 12th consecutive quarter of double-digit growth. According to the management, online sales have reached $1 billion with “strong profitability.” Digital penetration increased 340 basis points in Q4, expanding to just under 31% of revenue in the fourth quarter, compared to 27% in the prior year period. We expect this strong growth to continue going forward.

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