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Investment Overview for American Eagle Outfitters (NYSE:AEO)

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1. Latest Earnings

American Eagle Outfitters' positive momentum in the back half of FY 2017 has continued in Q1 2018, for which the company posted a 9% growth in revenues and a massive 44% improvement in earnings, with both metrics coming in higher than expected. AEO posted an overall comparable sales growth of 8%, driven by 38% comps improvement at Aerie and 20% increase in digital sales. Higher sales, a reduced promotional environment, benefiting from improved consumer confidence, and a lower tax rate were the main factors that resulted in the earnings growth. Looking ahead, the company has guided for a mid-single-digit comps growth, gross margin improvement, and a 42% to 52% rise in the EPS in the second quarter.

2. Aerie's Campaign

The company's game-changing campaign in 2014 for its Aerie brand, where the lingerie brand decided to feature only unairbrushed models in its ads, has paid off for the company. It has since then gone from strength to strength, driving sales growth for the company. It posted a 14th consecutive quarter of double-digit comps in Q1 2018, at 38%, building on the 25% seen in the prior year period. In addition to impressive growth in core intimates, the company has seen strength in apparel, active wear, and swim wear. The company expects the brand to cross $1 billion in sales in the next couple of years, with a lot of this growth coming from its digital channel, which grew at 50% in the quarter. Looking ahead, the brand remains poised for long-term growth as it continues to push through new ideas and fabrics. Moreover, since only 50% of women who shop at the AE brand are Aerie shoppers, it presents the brand with plenty of room to grow. Aerie is also expanding its store count, with 35 to 40 new stores expected in 2018.

3. Direct Business

As is the case with other apparel retailers, AEO is gradually shrinking its store count, and focusing more on the high margin e-commerce channel. A soft and gradual reduction in its brick-and-mortar footprint, as opposed to a large closure in one go, is a good decision as it would not result in a steep fall in sales. AEO reported digital sales growth of over 20% in the first quarter, making it the 13th consecutive quarter of double-digit growth. Digital penetration increased 300 basis points in Q1, expanding to 29% of revenue, compared to 26% in the prior year period. The company saw the biggest improvements coming from its app and mobile channels, which together represent roughly half of the retailer's digital business. AEO continues to invest in technology and its omnichannel capabilities, which should ensure sustained growth from this segment.

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1. American Eagle Stores EBITDA Margin

American Eagle Stores EBITDA Margin: EBITDA margins for AEO improved in recent years, from 19.5% in FY 2013 to 23.6% in FY 2016, driven by increased sales and fewer promotional activities. Lower expenses due to store consolidation also helped, together with favorable product costs and sourcing efficiencies, and maintaining tight inventories through more strategic and targeted promotions. However, in FY 2017, the metric underwent a decline, given the increasing shift to the online space, as well as higher promotional activity.

Going forward, however, we expect margins to decline gradually in the short term as the industry scenario remains highly promotional and the company incurs additional expenses due to the growing proportion of web sales. It is expected to stabilize thereafter, as higher full-price sales should make up for the increased costs.

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American Eagle Outfitters is a leading specialty apparel retailer that operates under the American Eagle Outfitters (AEO) and Aerie brands. The retailer designs, markets, and sells its own brand of high quality, on-trend clothing, accessories, and personal care products at affordable prices, while targeting 15-25 year old customers. Through its Aerie brand, the company offers a collection of intimates and personal care products for girls. Aerie emphasizes comfort rather than glamor when it comes to women's lingerie.

Most of American Eagle's retail presence is confined to the U.S., Canada, and Mexico. It operates a few retail stores in China and Hong Kong, and 214 licensed stores in 25 countries. In addition to this, it operates web-based stores for its different brands, through which it ships its merchandise to 81 countries across the world.

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Aerie revenue continues to grow at a strong pace

American Eagle's lingerie and activewear brand, Aerie, has gone from strength to strength, driving sales growth for the company. It posted a 14th consecutive quarter of double-digit comps in Q1 2018, at 38%, building on the 25% seen in the prior year period. In addition to impressive growth in core intimates, the company has seen strength in apparel, active wear, and swim wear. The company expects the brand to cross $1 billion in sales in the next couple of years, with a lot of this growth coming from its digital channel, which grew at 50% in the quarter. Looking ahead, the brand remains poised for long-term growth as it continues to push through new ideas and fabrics. Moreover, since only 50% of women who shop at the AE brand are Aerie shoppers, it presents the brand with plenty of room to grow. Aerie is also expanding its store count, with 35 to 40 new stores expected in 2018. We expect the brand's sales to improve 24% in 2018.

Internet & Catalog Orders' revenue growth is faster than American Eagle's mainline stores

With the rise of internet shopping, the Internet & catalog revenues as a share of the total revenues for American Eagle has been on the rise, accounting for 29% of the company's overall revenues in the first quarter. The US apparel industry is gradually shifting towards omni-channel retailing, which refers to providing a seamless shopping experience across stores and the online channel. This is becoming an inevitable move for US apparel retailers, including American Eagle, which is working hard to develop its omni-channel platform and has shown significant progress so far. As is the case with other apparel retailers, AEO is gradually shrinking its store count, and focusing more on the high margin e-commerce channel. This lends credence to its decision to develop its omni-channel presence by investing in digital marketing, and improve its website and mobile app.

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Weak brand loyalty for American Eagle

The U.S. teen apparel market is currently highly promotional, where each retailer is trying to outsmart the other one with a broader and deeper set of products. As a result, U.S. buyers have shown low brand loyalty as they have been readily shifting to the brands that provide relevant fashion at affordable prices. This trend has helped the growth of fast-fashion companies such as Gap Inc, Urban Outfitters, Zara, Forever 21, and H&M. On the other hand, companies such as American Eagle Outfitters, Abercrombie & Fitch, and Aeropostale have been at the receiving end of this trend.

Greater focus on fashion offerings

While American Eagle’s core products have struggled, its limited fashion range has found good acceptance among customers. As a result, the company is looking to strengthen this product category with more innovation in distinct finishes, fabrics, and washes. The company is looking to gradually shift its product portfolio from basic to fashion and has already seen some success. American Eagle is planning to simplify its designing system to respond to changing customer tastes quickly and effectively. It is removing layers within its designing teams, reorganizing the structure to implement direct accountability, and enhancing its speed sourcing capabilities. One such development on this front is the retailer’s fast-track fashion capsules, whose designing to in-store receiving process takes just 60 days. By effectively leveraging these factors, the company will be able to increase the proportion of fashion products in its portfolio.

Growth of young brand Aerie

American Eagle Outfitters sees huge potential in its relatively new brand, Aerie. The company is looking to capitalize on the 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. With the right push, we believe that Aerie can follow in the footsteps of Victoria’s Secret. The brand can fend off the fierce competition in the intimates market as its products are affordable and more about usability than glamor.

International Expansion.

The apparel market in the U.S. is highly saturated and competitive with a large number of established brands. Moreover, the sluggish economic growth has been a big worry for the entire industry. Last year in particular, apparel retailers struggled to achieve positive growth as cautious consumer spending and changes in spending patterns have weighed on sales. Given the situation in the U.S., exploring opportunities in international markets is warranted. It will not only open new revenue channels for the company, but will also help diversify the business risk geographically. With slightly better macroeconomic conditions and lesser competition, international markets might provide American Eagle with the opportunity to operate more full priced sales.

Development on omni-channel platform

With e-commerce not turning into a big business for many retailers despite continued robust growth, the need for omni-channel retailing has emerged. The entire apparel industry is gradually shifting towards this concept, which appears to be the future of retailing. Over the past couple of years, American Eagle has taken several steps towards the development of its omni-channel platform and all of them have shown good promise so far. Its "buy online and ship from the store" pilot program has helped it attract those customers, who could have shied away from the retailer if the inventory pool wasn’t integrated across all the channels. The initial roll out was slow, but the company soon went aggressive on its deployment.

The retailer reported that its BOSS program has exceeded all expectations, and this might help it operate with fewer markdowns and better inventory utilization in the future. Also, American Eagle has improved its delivery time significantly and it now delivers products in two days or less to more than 90% of its customers. It opened a new "state of the art" fulfillment center in Pennsylvania in July 2014, that has played an important role in improving capacity and delivery efficiency. In addition, American Eagle has several other projects planned that are intended to optimize shopping experience across online and mobile channel. It is in the process of adding new features to its website including 360 degree product view and more on-body product display. The company is relaunching an updated version of its mobile app, that will now run faster and have a better interface.

All these efforts, along with the anticipated growth in online apparel sales, are likely to help American Eagle improve its store productivity.

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