Strong Q4 Retail Trends Could Lift AEO

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American Eagle Outfitters’ positive Q3 2010 results provide some cheer heading into the holiday shopping season. The company generated a 1% year-over-year (YOY) improvement in same-store sales with SG&A down slightly YOY (excluding $2.5 million in severance charges) and end-of-quarter inventory per square foot down 2% YOY.

In the days between AEO’s Q3 2010 earnings release and the Thanksgiving holiday, AEO’s stock rose roughly 5% to $16.81, still 35% below the Trefis price estimate of $25.70. Encouraging retail data for early holiday shopping could help to close the gap should investors gain confidence in a resurgence of retail spending. However, we note that aggressive holiday promotions could hinder EBITDA margins and provide a slight headwind to profitability.

American Eagle Outfitters (NYSE:AEO) competes with Aeropostale (NYSE:ARO), Gap (NYSE:GPS), Abercrombie & Fitch (NYSE:ANF), and Urban Outfitters (NASDAQ:URBN) in the specialty retail apparel market.

We estimate that the company’s American Eagle brand stores constitute almost 50% of AEO’s stock value. Our forecasts reveal that a 5% change in 2011 American Eagle revenue per square foot translates to a 2% move in the price estimate. A 50 basis point change in 2011 American Eagle store EBITDA margin translates to a 1-2% change in price estimate.

Holiday Sales Trends Could Push AEO…

A National Retail Federation survey quoted by The Wall Street Journal cited an 8.7% YOY jump in online and store traffic to 212 million shoppers during the period between Thanksgiving and Sunday. Furthermore, average spend estimates showed a 6.4% YOY increase to $365.34 [1].

American Eagle Stores revenue per square foot saw a sharp decline between 2007 and 2009 due to falling demand in the apparel industry alongside the economic downturn. We currently project a more gradual improvement between 2010 and 2013 with a 4.6% CAGR. Our estimates could see further upside as positive trends continue through the holiday season and into 2011.

… But Be Mindful of Promotional Initiatives

Revenue upside from encouraging holiday shopping trends should be taken with caution as increased revenue often comes at the hands of promotional initiatives. Despite this effect, AEO profits should continue to be buoyed by improving EBITDA margins. We estimate a 70 basis point improvement in 2010 EBITDA margins to 12.4%, following a string of annual declines between 2006 and 2009.

Our forecast show a 1-2% AEO price sensitivity to a 50 basis point change in 2011 American Eagle store EBITDA margins. As we advance deeper into the holiday shopping season, investors should watch the development of trends in December sales to dissect the impact of bargain-hunting shoppers on early retail strength before deciding if this points to a more widespread improvement in consumer confidence.

See our full estimates for American Eagle Outfitters here.

  1. See Store Traffic, Sales Rise Over Black Friday Weekend []
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