One of the leading apparel chains in the U.S., American Eagle Outfitters (NYSE:AEO), has had a tough time in the recent past due to poor response to product changes and an overall weakness in the U.S. apparel industry. The company reported dismal sales for fiscal 2013, and slashed its outlook for the first quarter of fiscal 2014 on account of extreme weather conditions. Owing to industry weakness, American Eagle’s near term growth is likely to remain slow as most of its business is confined to North America.
However, the retailer’s international business is quite important from a long term perspective as it helps in diversifying risks geographically. Although American Eagle’s international presence is limited to just 66 franchise stores in 12 countries, it is looking to speed up its expansion and appears to be targeting the right markets for the purpose.  Last year, American Eagle assumed control over its six franchise stores in China, marking the start of its retail expansion in the country. Same year, the company initiated its expansion in Mexico and ended the year with 16 retail stores. These regions are two of the most important developing markets and provide good potential for value-for-money brands.
Our price estimate for American Eagle Outfitters stands at $17.75, implying a premium of more than 55% to the market price.
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How Can International Expansion Help?
The apparel market in the U.S. is highly saturated and competitive with a number of established brands. Moreover, the sluggish economic environment has been a big worry for the entire industry. Last year in particular, apparel retailers struggled to achieve positive growth as cautious consumer spending, change in spending patterns and persistently poor weather weighed on their sales. Moreover, teen buyers have been readily changing brands based on their changing tastees, which has troubled a number of players. American Eagle has been at the receiving end of this trend with its comparable store sales declining by 5%, 7%, 4%, and 7% during the successive four quarters of fiscal 2013.
Given the situation in the U.S., exploring opportunities in international markets is a good idea. It will not only open new revenue channels for the company, but will also help it reduce its reliance on the sluggish U.S. economy. Over the last one year, American Eagle’s stock has stumbled by almost 40% on account of its weak financial performance. By expanding internationally, the retailer will position itself better to regain its lost value. International markets with better macroeconomic conditions and relatively lower competition provide good expansion opportunities.
China Holds Tremendous Growth Potential For Western Retailers
In February 2013, American Eagle terminated its licensing agreement in China and Hong Kong to assume control over the existing stores. It also appointed Kitty Yung as the president of Asia-Pacific operations, with a mandate to devise relevant strategies for the region. Earlier, Yung had helped Guess‘s (NYSE:GES) Chinese operations to grow to over 200 stores, resulting in average annual revenue growth of close to 20% over the last four years. We believe that American Eagle’s strong growth fundamentals, the market’s potential and new leadership are likely assist its growth in the region.
Although the Chinese apparel market has struggled lately on account of consumer spending pullback, it is set to boom in the long term. With rising disposable income and growing urbanization, the market grew from $110 billion in 2009 to $140 billion in 2012, and is expected to touch $220 billion by 2016.  Moreover, eMarketer forecasts online retail sales in China to increase from $110 billion in 2012 to $440 billion in 2016.  The substantial rise in the region’s labor costs due to labor shortages, an ageing population and increased government regulation have all worked to drive growth in disposable income. The development of rural areas has encouraged the local population to look for work opportunities in their vicinity. This is preventing migration to urban areas, resulting in fewer workers and more expensive labor. Also, China’s population is aging and about 243 million Chinese are expected to be above the age of 60 by 2020.  The younger generation increasingly prefers college over factory work, which reflects increased awareness of education and the opportunities it affords. Apart from fueling labor costs, this trend is likely to enhance the youngsters’ living standards and increase the demand for specialty apparel.
While China provides tremendous opportunities for American Eagle, its U.S. counterparts Gap Inc. (NYSE:GPS) and Abercrombie & Fitch (NYSE:ANF) have also set their eyes on the market. Gap Inc has become one of the strongest western brands in the region, which has created a tough competitive environment.
Improving Living Standards In Mexico Bode Well For American Eagle
In 2013, American Eagle entered Mexico with its retail operations and opened 16 stores during the year. The retailer received encouraging customer response since it was already known in the region for the launch of its Mexico-specific e-commerce website in 2012.
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% of Mexicans are below 25 years of age.   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 an annual growth rate of 3.4% from 2012-2017, driven by improving lifestyles, 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 to major shopping centers across the country. This is a result of Mexican buyers laying greater emphasis on shopping experience, which is 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., Guess and Forever 21.Notes:
- American Eagle Outfitters’ Q4 fiscal 2013 earnings transcript, Mar 11 2014 [↩]
- China’s apparel retail market: $218 industry by 2016, Trans World News, Aug 3 2013 [↩]
- B2C Ecommerce Sales Climbs Worldwide, as Emerging Markets Drive Higher Sales, eMarketer, Jun 27 2013 [↩]
- China’s bid to provide care systems for elderly faces hurdles, warn experts, South China Morning Post, Sept 4 2013 [↩]
- Urban population (% of total), The World Bank [↩]
- Mexico Age Structure, Index Mundi [↩]
- Mexico-Apparel Retail, Market Line, Feb 5 2013 [↩]