American Eagle: Flying High
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American Eagle Outfitters Inc. (NYSE: AEO) holds a unique position with no debt in the typically highly leveraged retail industry. AEO shares have seen a good 30.5% run up year to date and are trading close to its 52-week high. Most of this upside is backed by the company’s focus on improving the direct-to-customer experience, shutting down underperforming stores, and making technological advancements, such as the e-commerce business.
The stock gained accelerated upward momentum after the newly appointed CEO, Robert Hanson, announced plans to exit 77kids stores on 18th May (describing it as an underperforming division) and after the company’s strong fiscal first quarter 2012 results, with a 25% year-over-year rise in earnings driven by a 17% year over year rise in same store sales.
AEO reported fiscal first-quarter 2012 earnings of $0.20 per share, in line with the consensus estimate and up $0.04 from last year. AEO’s revenue went up 18% year over year to $708.7 million, marginally missing the consensus estimate of $711 million. Growth in revenue was driven by a 17% increase in same store sales (versus -7% a year ago). Except 77kids, the company’s other three segments; AE Brand, aerie and AEO Direct reported impressive same store sales growth of 17%, 20% and 22%, respectively. We believe the company is on the right track to achieve its EPS guidance of $1.16-$1.22 in FY12 due to the following reasons.
Promising 2Q outlook and the back-to-school period: According to NRF’s back-to-school survey, families with children in kindergarten through 12th grade are expected to spend $688.62 on average for back-to-school items this year, up from $603.63 last year. We believe the back-to-school selling period (July-September) has the potential to be the next near-term catalyst.
The company is on the right track to capture higher consumer spending and has changed the merchandise flows for back-to-school relative to last year. The management has announced to bring two flows of merchandise into stores this year. The first set came earlier this month with a more “wear-now” offering relative to last year. A little later in the season, the second flow, will have the “denim impact” and carry more traditional back-to-school product. We believe the momentum AEO currently has in their bottom business bodes well for the next several months.
Same store sales momentum expected to continue in the remainder of the year: We expect strong positive same store sales momentum to carry throughout the remainder of the year (although not as robust as the 17% same store sales growth in Q1). We believe the company’s planned promotional activity and well-balanced spring/summer collection continue to drive traffic and conversion as early back-to-school products continue to show that AEO is ahead of its competitors with its merchandising. The company also remains focused on driving competitive top-line growth as well as accelerating e-Commerce growth.
Inventory catching up with sales: AEO’s total inventory at the end of 1Q12 was up 13.6% as compared to sales growth of 18%. While inventory is still elevated at the end of Q1, the company guided 2Q12 ending inventory cost per square foot to be up in the mid single digits and down in the mid-teens in the back half of 2012. We believe the company has made good progress aligning inventory with sales and expect improvement going forward.
Placed better than the competitors: Following AEO’s sector leading +17% same store sales in 1Q, the company is guiding to strong mid single digit same store sales in 2Q, well above trends at its primary teen apparel competitors. AEO’s biggest competitor, Abercrombie & Fitch Co. (NYSE: ANF) saw negative same store sales in its recent quarterly results. Going forward, we expect AEO to continue to perform better than Abercrombie, as AEO is likely to be benefited from having less exposure to weak European market than Abercrombie and franchised European stores (as opposed to Abercrombie’s company owned stores).
Gap Inc. (NYSE: GPS), another major player in the apparel industry, and AEO are both trading at a similar valuation, with AEO’s forward P/E of 14.11 marginally ahead of Gap’s 13.52. But, as per consensus estimates, AEO’s expected EPS growth is 45% (in F12) and 13.6% (in F13) compared to Gap’s 25.5% (in F12) and 11.3% (in F13). Thus, AEO is placed better and appears to be undervalued with respect to Gap on a PEG basis.
AEO is also providing a quarterly dividend of $0.11 since June 2010. This affirms a solid payout ratio of 53.0% and a healthy yield of 2.1% as compared to the average dividend yield of the industry of just 0.6%.
Going forward, other positives in favor of AEO include the company’s ability to maintain gross margins despite a spike in cotton price and the Aerie business’ progress and profitability. As the business scales, Aerie could contribute significantly to overall growth. Also, with easing cotton prices, the company can increase its gross margin. We believe the company has good growth potential and would definitely recommend AEO shares.
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