Is This Teen Retailer a Good Bet?

Ash is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

American Eagle Outfitters (NYSE: AEO) reached its lowest share price last July. Its sales growth has declined by 5% in the first quarter, but still it has been able to achieve operating profit of $57 million in the quarter. It has reported EPS better than the consensus estimate, despite bad weather and other headwinds. The company has made some strong decisions and invested in infrastructure and technology to improve margins. Its Aerie brand and factory stores are growth drivers and will increase sales with increased capital expenditure this year. Now, let’s discuss some of the company's growth initiatives in detail.

Omni-channel Investment will drive e-commerce sales growth

E-commerce sales have been the growth driver and contributed around 16% to total sales in fiscal year 2012. The company has invested in the omni-channel network to drive online sales. It has installed an updated CRM system, IBM sterling order management system, and global enterprise system for better order fulfillment. Its state of the art PLM system and new planning tool will help put location-based planning capability in place and cater to local demand. Free home delivery has added to sales growth, and with 35% of products available exclusively online, it will drive sales growth.

Aerie brand and factory stores

Aerie brand has seen 4% comps growth in the first quarter of this year, and the company is looking for more aggressive positioning of the brand. It has positioned itself in a way that will target older teens and young adult customers. The swim category is successful, and the company will look for brand extensions such as personal care and fragrances. Factory stores are another growth driver that has shown 1,000 bps better operating margin performance than the company's mainline business. It has sales growth potential of $500 million in the next few years, it's contributing 15% of sales, and has the opportunity to make it 20% like some of its competitors are doing.

Increased capital expenditure will help it to achieve higher margins

In the last few years its capital expenditure has averaged around $100 million. It has increased its capital expenditure for the year to $250 million-$280 million. This amount will be invested in new stores, remodeling, and factory stores. The company expects to open 50-55 AE brand stores and also to close 20-30 AE stores. Its new stores are highly productive and providing ROIC of 75%. It will also close 15-20 Aerie brand stores and open a new distribution center in Pennsylvania. Its investment in the new distribution center will increase supply capacity and cater to online orders, helping to achieve high margin levels in the future.

Peer analysis

In the Specialty Apparels retail segment, the other two major players are Abercrombie & Fitch (NYSE: ANF) and Aeropostale (NYSE: ARO). Abercrombie & Fitch has taken cross-functional initiatives to drive growth in the long term. Its initiatives for margin growth are primarily focused on seven different work streams. It has also taken initiatives on global market research and study during the first quarter, which will help it explore growth opportunities in the future. Its international business is highly profitable and the company will look for its first stores in Seoul and Shanghai this year. Its international sales contribute 30.69 % to total sales, and have further growth potential with new store plans.

Aeropostale will look for margin growth in the second half of fiscal 2013, as it has included fashion to its stores. It has also focused on improving its sourcing and allocation process this year. The company has reported negative comps and EPS growth in the first quarter of this fiscal year. It will expect better results ahead with Woven Top and Bottoms and Denims expected to drive comps growth. Its increased penetration in fashion products will help drive sales growth in the "back to school" season.

<table> <thead> <tr><th> </th><th> <p><strong>P/S ratio</strong></p> </th><th> <p><strong>Op. margin</strong></p> </th><th> <p><strong>1 Yr. Fwd. P/E</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>American Eagle Outfitters</strong></p> </td> <td> <p>1.32</p> </td> <td> <p>6.74</p> </td> <td> <p>11.46</p> </td> </tr> <tr> <td> <p><strong>Abercrombie & Fitch </strong></p> </td> <td> <p>1.15</p> </td> <td> <p>-1.66</p> </td> <td> <p>12.52</p> </td> </tr> <tr> <td> <p><strong>Aeropostale</strong></p> </td> <td> <p>0.6</p> </td> <td> <p>-4.53</p> </td> <td> <p>21.86</p> </td> </tr> </tbody> </table>

Source: Google Finance and Yahoo Finance

American Eagle has reported the highest operating margin of 6.74% and the lowest one-year forward P/E of 11.46 among the three mentioned peers. Abercrombie & Fitch has reported -1.66 operating margin and P/S ratio of 1.15. Aeropostale has reported the lowest operating margin of -4.53 and the highest forward P/E of 21.86.


American Eagle Outfitters has invested in the omni-channel network and updated its IT infrastructure to increase online sales this year. Aerie Brand and Factory store sales have performed better than the company’s average sales. It has also increased its capital expenditure on new store growth, closures, and remodeling. Its investments are expected to drive sales growth in the future. The company is trading at a forward PE of 11.66 times. Its EPS forecast is 1.44 for the current year and 1.65 for next year, which is an estimated 14.68% year-over-year growth. According to consensus estimates, the company's top line is expected to grow 6.10% over the next year. With a PEG ratio of less than 1, the stock looks attractive. Also, it seems like the company is gaining market share from Aeropostale, which is expected to post a year-over-year decline in sales this year. The company has a dividend yield of 2.60%, which is highest among the teen retailers. I recommend a ‘buy” for long-term growth.

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Ash Sharma has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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