American Eagle Preview: What We’re Watching on Wednesday

With its primary competitor in the cheap teen retail segment Aeropostale (NYSE:ARO) in dire straits on the heels of a string of disappointing announcements, we are eager to hear what American Eagle Outfitters (NYSE:AEO) will say on Wednesday. The gross margins trend and sales outlook are two of the key metrics that will drive the stock’s performance. American Eagle, Aeropostale and Abercrombie & Fitch (NYSE:ANF) form the triad of  teen apparel retail in America, and the shares of Abercrombie and Aeropostale are down around 20% in the last 3 months compared to nearly 40% for Aeropostale. With a limping economy that increasingly looks like it might enter a recession, the big question is how these retailers’ sales will fare in the second half of the 2011.

We have a $20 price estimate for American Eagle’s stock, which is well above the current market price.We will revise our estimates following earnings as we update our forecast.

Gross margins remain in focus

Gross margins are a key metric to analyze a company’s performance in apparel market. AEO reported a decline of 1.9 percentage points in its margins in last quarter, which has been the primary reason behind the under performance of its share since May.

The following items are impacting its gross margins:

Price of Cotton: The rise in cotton prices have been the primary factor behind the margin woes throughout the apparel industry. With the cotton prices showing signs of returning to normal, ^[1] it will be interesting to follow the impact of this on AEO’s margins.

Cotton prices are important for apparel retailers like American Eagle as these companies often shy from passing the costs to consumers in fear of losing their business.

International expansion: An aggressive international expansion program is on the forefront of AEO’s strategy going forward. Almost all of the company’s international business is through a franchise model, which requires significantly less investment and therefore can lead to better margins. With five successful stores in Dubai, Kuwait City, and Hong Kong and more on the cards, we expect the growth in international business to improve the margins of the firm.

Growth in Internet Orders: Internet & catalog orders contribute 25% to AEO’s stock according to Trefis price estimate. AEO posted growth of 3% in e-commerce last quarter, which came at a time when all other divisions of company underperformed. We expect this growth to continue particularly after the launch of Back-to-School Social Media Photo Campaign on July 21st. ^[2]

E-commerce sales hold importance for the company because the margins for internet & catalog business are roughly twice that of American Eagle stores. Strong growth in this channel implies an improvement in margins for the teen apparel retailer.

See our complete analysis for American Eagle Outfitter’s stock here

1. Falling cotton prices, Source : Index Muni [↩]
2. American Eagle Outfitters Launches Back-to-School Social Media Photo Campaign, July 21, 2011 [↩]