American Eagle Readies for Holiday Push After Encouraging Q3 Results

Teen specialty retailer American Eagle Outfitters (NYSE:AEO) reported earnings November 30th posting net sales increasing by 11% compared to that of last year. ^[1] However the company continues to struggle with the higher input costs, which combined with the effect from increased promotions during the quarter, resulted in a decline of 4.5% in American Eagle’s gross margins. We believe the results have been promising, considering the fact that the company was able to post positive comps across all of its brands. Additionally the start of fourth quarter too has been promising, with the company reporting a strong business over the Thanksgiving weekend. American Eagle Outfitters competes with specialty retailers such as Aeropostale (NYSE:ARO), Abercrombie & Fitch (NYSE:ANF) and Gap Inc. (NYSE:GPS) in teen apparel space.

We have increased our price estimate for American Eagle’s stock to $17.75, which is roughly 25% ahead of current market price. The adjustments in our price estimate primarily reflects American Eagle’s net cash/debt position along with our improved outlook for next quarter sales.

Check out our complete analysis of American Eagle Outfitters

Improvement in comp sales across all brands a positive sign

One of the major highlights of third quarter’s result was an improvement in comp sales across all the major American Eagle Outfitters’ brands. The growth in its major brand American Eagle was driven by a strong performance in bottoms, particularly for women’s denims. Learning from its mistakes in 2010, the company invested smartly in its inventories this quarter to capitalize on traffic during peak periods. For its intimate apparel brand aerie, the launch of the Drew bra was the major growth driver this quarter.

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Additionally the company continued its strong run in direct business. The company posted a strong growth of 21% in its direct business  benefiting  primarily from impact of online promotional campaigns. The company also strengthened its mobile business with the launch of AE mobile app along with providing the option of shopping with Google Wallet.

Increasing promotions and high costs weigh on margins

Though both the results and outlook on revenue side were encouraging, American Eagle continues to struggle with increasing promotions and high cotton prices. For this quarter, the company had to increase the depth of its promotions to attract the consumers in order to improve its comp sales, which eventually echoed through a decline in margins. Alongside high cotton prices remains a source of concern for American Eagle and also contributed to the margin decline.

For the next quarter we expect the margins to fall 3-4% below to that of Q4 last year as most of American Eagle’s holiday campaign was built around promotions. The apparel market continues to be highly promotional in nature and we expect the trend to continue for the Christmas holidays too.

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1. American Eagle reports Q3 results, Source: American Eagle’s IR [↩]