Outfits That Have Outperformed!

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

Apparel continues to be a bright spot for the U.S. economy as customers are willing to splurge a little on new fashions or accessories, but still shun big ticket items. Among such retailers, American Eagle has long been among the favorite places for teens to pick up the jeans that form the foundation for many of their wardrobes.  It is a leading retailer that operates under the American Eagle Outfitters, “aerie” and 77Kids brands. The offerings of the company’s core brand include jeans, cargo pants, and graphic T-shirts, as well as a collection of accessories, outerwear, and footwear for people ranging between the ages of 15 to 25.

The company's consistent earnings performance is encouraging, as it has continually met or beat forecasts in the past several quarters. Driven by strong top-line growth coupled with lower input and operating costs, American Eagle Outfitters (NYSE: AEO) reported strong second quarter performance for the fiscal year 2012 with earnings of $0.21 per share, which surged nearly 62% from last year’s reporting period. Adjusted net sales increased 11% year over year to $739.7 million, beating the estimate of $738 million. Furthermore, it has a solid year-to-date return of 32.3%, and with numerous positive catalysts, the stock looks poised to keep the winning streak going.

But last month, American Eagle said its fiscal second-quarter earnings edged down 3.3% on losses tied to the sale of its children's business, though it recorded stronger-than expected sales as it cut down on discounts and saw traffic pick up. An emphasis on fashion, which represents about 25% of women's merchandise and 15% of men's, has given a boost to the company, as teen retail customers head toward trends and away from basics.

Special Dividend for Fashionable investors

American Eagle unveiled a special dividend of $1.50 a share, marking its second bonus payout in less than two years along with its regular quarterly cash dividend of 11 cents per share. The company boasts of a long track record of consistently paying quarterly dividends for more than 8 years. The announcement of special cash dividend was primarily aided by the company's strong balance sheet position and ability to generate excessive free cash flow. The special dividend is expected to cost the company roughly $295 million. Chief Executive Robert Hanson said the special dividend is part of the retailer's capital allocation plan, which balances continued investment in the company's business with shareholder returns. The global specialty retailer stated that the declaration of the latest quarterly dividend marks the 33rd consecutive quarterly dividend payment. Subsequently, shares climbed to their highest point in more than four and a half years.

International expectations

It has been a mixed season for teen-oriented apparel makers. Bolstered by a strong quarterly performance, management raised its fiscal 2012 earnings guidance range to $1.33-$1.36 per share from $1.16-$1.22 forecasted earlier. The retailer said it sees comparable store sales rising in the mid-single digits in the third quarter and the low-single digits in the fourth quarter. For third quarter 2012, the company expects earnings to be in the range of 37 cents - 38 cents per share. Going ahead in 2012, the company expects its profits to grow continually, given the right mix of products and marketing plans.

American Eagle plans to double its outlet stores and increase direct-to-consumer sales—initiatives that stand to increase cash generation going forward. Moreover, the Company plans to close 20 to 30 underperforming stores a year, while adding 50 to 100 new stores in key shopping mall locations, resulting in a square footage increase of 1 to 2%. American Eagle continue to gain pace as it takes another step forward towards growing internationally.  After making its presence felt in Israel, Japan, and the Middle East; the company is targeting to capture the strong and promising Philippines market, by entering into a multi-year retail license agreement with the Philippines based Suyen Corporation.

Robust Q2 results, increased 2012 outlook, impressive track record of paying regular dividends, and strategies to grow internationally, are the primary drivers for this stock.

American Eagle has the best product. 

AEO is touted as the more popular alternative to a higher-priced American brand known for its longtime uniform of pricey denim and graphic T-shirts. Further, we remain impressed with the company's continued momentum in denim along with improved merchandise assortments in the women's business segment, which will likely augment its top-line performance and enhance gross margin.  Moreover, the company's strong portfolio of well established brands, each of which is focused on the unique characteristics and rapidly changing preferences of customers make American Eagle a leading specialty retailer of fashionable and stylish apparels and accessories in the United States and Canada. While sales can be affected by economic factors, American Eagle is a good example that product is king. 

As a strategy, the company remains committed to enhance store sales productivity by increasing focus on its merchandise assortments, adding more compelling brands, managing inventory level much diligently and augmenting e-commerce business, while simultaneously shutting down underperforming stores. In order to emphasize more on core business and generate the best possible return for shareholders, American Eagle is moving ahead with its plans to exit its children's brand - 77Kids.  Moreover, we believe the company's cost-saving initiatives and long-term growth strategy will not only provide financial flexibility, but will also help to drive value.

AEO beating every other teen retailer

Retailers like American Eagle have been operating in an intensely competitive environment marked by bargain-hunting consumers and deep promotions.  Nevertheless, operating in the highly fragmented specialty retail sector, it faces intense competition from other teen-focused retailers, such as Abercrombie & Fitch and Gap and Aeropostale 

While Abercrombie and Aeropostale stuck to their old, preppy designs, American Eagle has made an effort to differentiate its product. It has introduced new clothing lines to appeal to teenagers, putting it in a competitive position as it enters the back-to-school shopping season. The company has been a standout in the teen sector as high-end peer Abercrombie & Fitch and bargain player Aeropostale both recently reported weaker fiscal second-quarter amid disappointing same-store sales. They were struggling in the last quarter to keep the right mix of colorful clothing on their shelves. There are other factors too.

Abercrombie & Fitch (NYSE: ANF) has not fared as well due to its higher pricing than other teen retailers. Its market cap is $3 billion compared with a revenue forecast of $5 billion for fiscal 2014.  ANF is a larger company than AEO, with a greater store base and higher net sales than AEO.  Although ANF is one of AEO's most direct competitors, the two companies operate with different strategies: Abercrombie maintains a premium brand with high price points while American Eagle attempts to reach a larger range of customers with relatively lower price points on trendy products.

 Aeropostale's (NYSE: ARO)
market cap is $1 billion compared with a $2 billion in revenue estimated for fiscal 2014. Aeropostale's stock has already been punished for its weak second-quarter earnings results, which were dragged down by heavy discounting during the back-to-school season.  Aeropostale's shares are down 33% since late July.  ARO is a smaller company than AEO, with the overwhelming majority of revenue coming from only its namesake brand of stores that targets 14 - 17 year olds.  Aeropostale's business model also relies heavily on sales and promotions, something that AEO is trying to move away from in order to keep margins high.

Gap (NYSE: GPS) is a much larger company than AEO in terms of sales, stores and customer segments targeted. Through variations on Gap (Gap Kids, babyGap, Gap Maternity) the retailer serves a wide range of customers; also, Banana Republic and Old Navy stores serve different socio-economic segments.  Because of the wider range of customers, Gap doesn't match up with AEO as closely as some other competitors, however there is considerable overlap. The recent quarter net income was $243 million, or 49 cents per share but its full-year guidance missed analysts' estimates.

The reason why American Eagle is doing so well in comparison to its competitors is obvious. Abercrombie & Fitch and Aeropostale could see more gains going forward than rival American Eagle, whose market cap of $4 billion is bigger than its revenue forecast of $3 billion for fiscal 2014. Even as its main competitors, Aeropostale and Abercrombie & Fitch, struggled through back-to-school season, American Eagle dominated. 

The Bottom-Line

American Eagle Outfitters is soaring high among today's young shoppers who go for hip, indie, and cool clothes at down-to-earth prices. Key strengths of this leading fashion retailer include strong top line growth, better cost management, escalating operating profit margin, admirable financial power with lower debt levels, good capital allocation, and solid cash flows. Solid brand acceptance and incremental store remodels are expected to further drive store productivity.

All the above discussed points demonstrate the company's strong fundamentals and its ability to keep up with the momentum.  As a result, this stock offers several reasons to own it.

MihirMehta has no positions in the stocks mentioned above. The Motley Fool owns shares of Aeropostale. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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