American Eagle Not a Child’s Play
Jon is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Abercrombie and Fitch (NYSE: ANF) has been having a rough go at it lately. They are down 50% over the course of the past year. Although sales revenue has been up the past three fiscal years, net income was down 15% fiscal 2011 from the year before. So far this year, Mr Market hasn’t enjoyed their earnings reports either.
Top competitor American Eagle (NYSE: AEO) has been hitting its stride recently in the market as they are up over 70% over the past year. Interestingly enough, sales revenue has been basically flat the last three fiscal years, and net income was down 16% for fiscal 2011. At first glance, there doesn't seem to be a 120% difference between these two companies. What is it exactly that has American Eagle soaring on investor thermals?
|Company||Market Cap||P/E ratio||Dividend/Yield||52 week stock change|
|A and F||2.97 B||29||$0.17/1.95%||-49%|
What is interesting, is that when it comes to these fundamentals, nothing stands out. American Eagle is not the best in any of these categories, nor are they they worst. It makes me think that something else has investors positive. Here are some thoughts as to what it might be.
One of the main things that came out in AE’s most recent quarterly report was that they were getting out of the kid’s clothes business. Their brand “77kids” hasn’t really delivered for them in the way that they had hoped. In fact, it hasn’t delivered at all. For fiscal 2011, 77kids took them down with a whopping $23.6 million loss. In formal economic jargon we would say that is “not good.”
American Eagle has taken note of this and has decided to end the 77kids operation. The exact details to which have not been revealed. One of the options on the table is trying to sell the business to a third party. No matter what they decide to do, it’s going to effect some margins in the short term. Granted, the ongoing net loss of 77kids was already affecting margins, but getting out of this business will also cost the Eagle some money. It is likely going to cost them $16 million in the second quarter, and then “remaining exit charges” will also affect the second quarter and in to the third quarter as well.
Before you push the panic button consider that the business itself is already incurring losses, and it makes sense to just suck it up, cut your losses and move on. The result is going to be lower net income then American Eagle would like in the coming quarters. But, having this profit leech gone will definitely make the fourth quarter report look better, and also on into next year.
One of the interesting things that American Eagle has cited in the business growth plan is heading into international markets. They plan to do this mainly by way of franchises. Franchises are easier in many ways for a company, as they are cheaper to get going and any losses that occur aren’t on the company but rather on the franchise. In the most recent quarterly report they showed that they now had 34 international franchises, way up from just 5 a year ago.
When discussing where else in the world they would like to open franchises they cited “Middle East, Northern Africa, Eastern Europe, Hong Kong, China, Israel and Japan.” You may be curious how well “American” eagle clothes would sell in places like the Middle East and Eastern Europe because, well America isn’t exactly popular everywhere. Just keep in mind that American Eagle hasn’t said that they are planning to open company owned stores, but rather franchises. This minimizes risks while they test out new markets. Maybe Northern Africa won’t go over well. Perhaps Hong Kong will. This is almost a chance for them to get feelers out there to see where they could expand. Maybe if they find a good new market they could open company owned stores that could generate a higher profit.
I'm not saying that American Eagle is the best play of the stocks I have mentioned. Do your research to arrive at that conclusion. What I have attempted to show is some reasons why investors may already be excited about American Eagle's long-term growth. We'll certainly have to wait and see.
But one last word of advice. If you are excited about getting in on AEO, consider waiting until after the next quarterly report. Management has already discussed how the 77kids exit could adversely effect that report, and you might see a temporary drop in stock price allowing you to get it at a discount.
thequast has no positions in the stocks mentioned above. The Motley Fool owns shares of The Buckle and Guess?. Motley Fool newsletter services recommend Guess? and The Buckle. 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.