Aerie And Digital Segment To Drive Growth For American Eagle In The Second Quarter

American Eagle Outfitters‘ (NYSE:AEO) positive momentum is expected to continue in the second quarter, with an 11% growth in sales and a 63% improvement in earnings anticipated by analysts. Impressive results posted by Urban Outfitters has buoyed the apparel retail industry, with higher consumer confidence translating to increased spending. The company’s recent trends of Aerie and the digital segment driving revenue growth, and higher sales, a reduced promotional environment, and a lower tax rate resulting in a growth in earnings, are expected to continue this time around, as well. The management has guided for a mid-single-digit comps growth, gross margin improvement, and a 42% to 52% rise in the EPS in the second quarter.

We have a $25 price estimate for American Eagle, which is lower than the current market price. The charts have been created using our new, interactive platform. You can click here for our interactive dashboard on Our Outlook For American Eagle in FY 2018 to modify the different drivers, and arrive at your own price estimate for the company.

Factors That May Impact Performance

1. Impressive Jeans Performance: A significant amount of market share in the jeans market is up for grabs as a result of bankruptcies and store closures in the apparel retail space in the U.S.  According to Statista, AEO’s market share was approximately 3.7% in the 2010-2015 time period. However, as per an update provided by the company, its share has risen to 7% by brand and by retailer. Moreover, the company is the second biggest denim retailer in the country, and in the 15 to 25 age group among specialty jeans, American Eagle jeans occupy the top spot with a 31% market share. There is scope for further improvement in this metric as more and more retailers fall prey to bankruptcies. In the first quarter, the company delivered its 19th straight quarter of record jeans sales, with further growth expected in the second quarter given the advent of the back-to-school season.

2. 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 14th consecutive quarter of double-digit comps in Q1 2018, at 38%, building on the 25% 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 grew at 50% in the first quarter. 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.

3. Growth of Digital Segment: AEO reported digital sales growth of over 20% in the first quarter, making it the 13th consecutive quarter of double-digit growth. Digital penetration increased 300 basis points in Q1, expanding to 29% of revenue, compared to 26% in the prior year period. The company saw the biggest improvements coming from its app and mobile channels, which together represent roughly half of the retailer’s digital business. AEO continues to invest in technology and its omnichannel capabilities, which should ensure sustained growth from this segment.

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 had anticipated the sequential improvement in margins to continue in FY 2018, and consequently, we had expected the gross margin in Q1 2018 to be higher than that in the corresponding quarter of FY 2017. AEO was able to deliver on this, with the gross margin rate increasing 50 basis points in the quarter. This was 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. AEO has guided for an improvement in the metric for the second quarter as well, which implies that the improved consumer confidence will continue to reduce the need for higher promotions.

5. Higher Retail Sales: According to the U.S. Census Bureau, retail sales were up 6.6% in June 2018 versus June 2017, and 0.5% higher than May 2018. Categories with strong growth included clothing/clothing accessories, which rose 5.1% as compared to the previous year, a factor that should bode well for apparel retailers.

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