Earnings Preview: American Eagle’s Flight May See Some Headwinds

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AEO: American Eagle Outfitters logo
AEO
American Eagle Outfitters

Teen apparel retailer, American Eagle Outfitters (NYSE:AEO) is scheduled to report its Q1 fiscal 2015 earnings on May 20th and we expect it to maintain its performance consistency after a promising Q4 fiscal 2014. The retailer’s revenues had increased by 3% in the final quarter of last year, its gross margins had expanded by 320 basis points and EPS had surged 33%. American Eagle’s growth was driven by an improvement in its merchandise portfolio, that was strong enough to dilute the impact of the industry-wide decline in foot traffic. This time around, we expect the company will report that growth was driven by improved customer response to updated merchandise and the strong performance from Aerie and the factory channel.  We believe that this was partially offset by a revenue decline through store consolidation and decline in foot traffic attributable to the ongoing online shift.

After several merchandise goof-ups and continuous reliance on logo products, American Eagle is finally beginning to get its product portfolio back on track. This has allowed the company to operate with fewer markdowns in the recent past, which we believe continued in the first quarter of fiscal 2015. The retailer’s intimates brand, Aerie, has been performing very well for some time now, and we see no reason why that might have changed in Q1. Factory channel continues to outperform rest of the store fleet, which would have had some positive impact on the first quarter revenue growth. However, with increasing adoption of online shopping, foot traffic across the retail industry has declined significantly. This trend continued in the first quarter of 2015, and would have had a negative impact on American Eagle’s comparable sales growth.

Our price estimate for the company at $14.07, is about 10% below the current market price.

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Better Merchandise Portfolio

A number of casual apparel retailers in the U.S. are working on their merchandise range to strengthen their footing against fast-fashion players such as Zara and Forever 21. Among them, American Eagle has shown small signs of improvement in its merchandise portfolio and it even has results to show for it. During the fourth quarter of 2014, the company was able to operate with fewer discounts, which is evident from its gross margin improvement and the rise in average retail prices. American Eagle’s mainline brand’s improvement was driven by better styles as well as proper inventory management that negated the need for markdowns. The management specifically mentioned in the earnings call that high attention to detail and innovation helped the sales of core categories such as knit tops, women’s denim, sweaters, men’s pants and accessories. Although it will take some time for this performance to transition across the board, it will definitely have some notable positive impact on the retailer’s namesake brand’s comparable sales growth in the first quarter.

Strong Aerie

American Eagle’s Aerie has grown strongly over the past several quarters, thanks to its balance of design and pricing, and lack of competition in the young women’s intimates specialty format. About 15% of the total female population in the U.S. are between ages 15 and 24. The overall lingerie market in the U.S. stands well over $12 billion, and is currently dominated by only a few established brands. The encouraging trend is that U.S. buyers have continued to spend on intimate products even during the sluggish economic environment. Victoria’s Secret has been a standout performer and though Aerie has not had the same success, it has performed better than the company’s main brand. American Eagle mentioned that its intimates brand had an outstanding year 2014, where new product lines were very well received and marketing campaigns resonated well with the target customers. The brand delivered a hefty 13% growth in comparable sales during the fourth quarter driven by strength in PJ’s and soft bottoms. The retailer mentioned that Aerie still has a lot of topline growth potential and we may see a glimpse of it in the upcoming Q1 results, though positive impact on overall results will not be too significant.

Promising Factory Channel

American Eagle’s factory channel, which was launched not too long ago, has been generating better sales than the company’s mainline stores. During 2013, factory stores delivered positive comparable store sales, despite the tough retail environment, and the retailer saw significant improvement in 2014 as well. Although currently this channel is not big enough to have a material impact on American Eagle’s results,  it is contributing positively nonetheless. Not just with growth in comparable sales, but also through incremental revenues from newly opened stores. The retailer opened 39 factory stores in 2013, another 26 in 2014 and we believe that it opened some in Q1 2015 as well. With a significantly higher number of stores in Q1 this year as compared to the year ago period and consistent growth in comparable sales, we expect factory channel to make a better contribution this time around.

Fall In Foot Traffic

Overall sales of clothing and clothing accessories stores for the month of February increased 2.5%, but most of that growth was attributable to the rise in online sales as foot traffic is falling consistently. [1] Weighed down by prolonged winter, store traffic across brick-and-mortar retailers in February fell a sizable 12.5% as fewer buyers got out of their homes for shopping. According to RetailNext, overall sales of brick-and-mortar stores fell 10.4% during the month, which can be used as an indicator for performance of store based apparel retailers as well. [2] While we believe that American Eagle’s overall online revenues would have increased considerably during the quarter, its growth would not have contributed much to the company’s overall growth due to the channel’s relatively small size. In March, overall apparel market growth remained stable at 2.5%, which indicates that market conditions did not change much through the month. In April however, Euclid reported that foot traffic increased 12% compared to the year ago period, which would have helped growth of retailers who earn a major share of their revenues through store sales. [3] However, overall sales growth of clothing and clothing accessories stores increased just 1.1%, implying that the rise in traffic around the Easter weekend was unable to overcome buyers’ reluctance to spend on discretionary products. This trend does not bode well for American Eagle.

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Notes:
  1. Clothing and Clothing Accessories Stores, U.S. Census Bureau []
  2. Winter Weather Wrecks Havoc on Retail Stores, PR Newswire, Mar 5 2015 []
  3. Study: April sales fall despite traffic boost, Chain Store Age, May 8 2015 []