American Eagle Outfitters (NYSE:AEO) is one of the leading apparel retailers in the U.S. and operates in a highly competitive, promotional and fashion sensitive environment. Its retail store presence is currently limited to North America, which makes it susceptible to the sluggish U.S. economy. However recently, the company came out with plans to speed up its international expansion to tap some lucrative markets and diversify its risks geographically.
The company recently assumed control over its six franchise stores in China and opened its first store in Mexico. It plans to continue expanding in these regions throughout the fiscal 2013. American Eagle also entered Philippines earlier this year through a franchise partnership and is planning to spread its operations throughout the region over the long-term. These regions are some of the most important developing markets and provide good potential for value-for-money brands.
China – Strong Market Growth Potential And New Leadership For Asia Pacific Operations
A few months back, American Eagle terminated its licensing agreement in China and Hong Kong to assume control over its existing stores.  It also appointed Kitty Yung as the president of Asia Pacific operations to devise relevant strategies for the region.  Previously, she had helped Guess‘ (NYSE:GES) Chinese operations to grow to over 200 stores, resulting in average annual revenue growth of more than 25% over the last three years.  We expect American Eagle to do well in China due to its strong growth fundamentals, the market’s potential and new leadership.
Even when the global economy was reeling under the impact of the recession of 2008-2009, China was able to sustain its economic growth with rising income levels and increasing urbanization.  The substantial rise in the region’s labor costs has been one of the primary reasons behind the increase in disposable income. At the end of 2012, about 53% of Chinese resided in urban areas, which was significantly lower than the proportion of the urban population in the U.S. and Japan.  This indicates there is a huge scope of urbanization and this figure could reach 65% by 2025. 
These factors have resulted in rapid growth in China’s apparel industry. Prior to 2011, the region’s apparel sales were growing at an average annual rate of about 16%. In 2009, the market stood at $110 billion and consulting firm McKinsey expects this figure to cross $200 billion by 2014.  On the other hand, growth in the U.S. apparel industry has been slow. This is why several U.S. apparel retailers such as Gap are aggressively expanding in China.
Mexico – Improving Lifestyle, Economic Growth And Adoption Of E-commerce
In early 2013, American Eagle announced plans to open its first store in Mexico and scale up the expansion depending upon the reception.  The retailer is already known in the region as it launched a Mexico-specific e-commerce website last year, and therefore it may not have to struggle much as far as brand advertising is concerned.
With rising disposable income and fashion consciousness, Mexico has become an attractive market for affordable brands. About 78% of the region’s population resides in urban areas and about 46% Mexicans are below 25 years of age.   This implies that a major portion of Mexico’s population is young, follows good lifestyle trends and is aware of fashion. This bodes well for the apparel industry’s long-term growth outlook. Currently the region’s apparel market size stands at around $5.7 billion and is expected to grow at a GAGR (compounded annual growth rate) of 3.4% from 2012-2017 driven by improving lifestyle, economic growth and expected increase in online retail sales. 
Historically, apparel products have been available in Mexico through a number of channels such as grocery chains and direct retailers.  However lately, specialty retailers have become much more popular and emerged as the most important distribution channel in the market in 2012.  These retailers are increasing their market share by expanding in major shopping centers across the country. This has resulted from Mexican buyers laying a greater emphasis on shopping experience, which is often better in a specialty store as compared to a department store.  Although these factors are encouraging for American Eagle, it will face tough competition in the region from brands such as H&M, Gap Inc. (NYSE:GPS), Guess and Forever 21. 
American Eagle has a limited international presence as it owns just about 49 franchise stores in 13 countries.  Recently, the company opened its first franchise store in the Philippines and plans to add more stores throughout the region in fiscal 2013.  American Eagle’s stores will be operated by Suyen Corporation, which is the leading apparel retailer in the Philippines, with a broad selection of popular brands at affordable prices. This will provide the retailer a competitive advantage and help it in creating brand awareness relatively easily as Suyen Corporation invests heavily on advertising and marketing. 
Although the market is small, it does offer good potential for value focused retailers due to its flourishing middle class and rising disposable income on the account of booming BPO (Business process outsourcing) industry and increasing remittances. Lately, the Philippines has become an important market for BPOs. ((How To Strengthen Outsourcing In Philippines, eastvantage)) In 2011, the region’s BPO industry reported $11 billion in revenues and employed 640,000 people.  The growth in this industry has been one of the main factors driving higher disposable income, thus in parallel helping the apparel industry’s growth as well.  Remittances refer to the money received from friends and relatives working abroad. This accounts for about 10% of the Philippines’ gross domestic product.  Towards the end of 2012, the region saw a steep rise in cash remittances. The year-over-year growth for October and November 2012, stood at 8.5% and 7.6% respectively.  Overall, the Philippines received more than $19 billion in cash remittances in 2012. We expect the trend to continue and influence consumer spending growth in the country positively which would bode well for the region’s apparel industry.
What’s The Significance Of This Expansion?
Currently, American Eagle is planning to open only franchisee stores in the Philippines and there seem to be no plans for its retail store expansion yet. However, it won’t be surprising if the company starts opening its retail stores in the region few years later. In China, we expect American Eagle to expand aggressively by adding 15-20 stores annually (similar to Gap). In Mexico, the company has six stores planned for the current year and we believe that it will open about five-six stores annually thereafter. Overall, if American Eagle opens about 20-25 stores every year in these three markets and they generate slightly better revenue per square feet (similar to what Gap has seen), there could be 10-15% upside to our price estimate.
Our price estimate for American Eagle Outfitters stands at $27, implying a premium of about 45% to the market price.Notes:
- American Eagle Outfitters To Assume Operations Of Six Existing Stores In China and Hong Kong, American Eagle Outfitters, Feb 4 2013 [↩]
- American Eagle Outfitters Appoints Kitty Yung To EVP/President Of Asia Pacific, American Eagle Outfitters, Apr 10 2013 [↩]
- Guess’ SEC filings [↩]
- Apparel In China, Euromonitor, Apr 2012 [↩]
- China’s population – Peak toil, The Economist, Jan 26 2013 [↩]
- United Nations, Department of Economic and Social Affairs [↩]
- From Mao to Wao: Winning in China’s Booming Apparel Industry, McKinsey, Jan 2011 [↩]
- American Eagle Outfitters To Launch First Store In Mexico, American Eagle Outfitters, Jan 28 2013 [↩]
- Urban population (% of total), The World Bank [↩]
- Mexico Age Structure, Index Mundi [↩]
- Mexico-Apparel Retail, Market Line, Feb 5 2013 [↩]
- Apparel in Mexico, Euromonitor International, Apr 2013 [↩] [↩] [↩] [↩]
- American Eagle Outfitters’ SEC filings [↩]
- American Eagle Outfitters Opens High Street Location In Philippines, American Eagle Outfitters, March 1 2013 [↩]
- Apparel in the Philippines, euromonitor, June 2012 [↩] [↩]
- BPO firms unfazed by Obama ‘job bill’, Business Mirror, Nov 8 2012 [↩]
- Philippine Remittances Rise Sharply, The Wall Street Journal, Jan 15 2013 [↩] [↩]