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Investment Overview for American Eagle Outfitters (NYSE:AEO)

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1. Latest Earnings

American Eagle Outfitters reported a better than expected performance in Q3 2019 (ending October). The clothing and accessories retailer handily beat consensus earnings and revenues estimates. Net sales for the company grew almost 6% y-o-y to $1.07 billion - its highest-ever level for the third quarter of a year, largely driven by a 20% jump in comps for Aerie and double-digit growth in the digital channel business. However, the company's gross profit rate contracted by 160 basis points, falling from 39.8% in Q2 2019 to 38.2% in Q3 2019. For the fourth quarter of FY 2019, the company expects earnings per share in the range of $0.34 to $0.36 while comparable sales are expected to remain flat. The company continues to focus on leveraging its leading brand position to expand its market share for the American Eagle brand, accelerating growth and expansion of Aerie, and elevating the customer experience. These factors should bode well for it in the future, ensuring strong growth in the years to come.

2. Strength of Aerie

American Eagle's lingerie and activewear brand, Aerie, has gone from strength to strength, driving sales growth for the company. It posted a 20th consecutive quarter of double-digit comps in Q3 2019, at 20%, building on the 32% seen in the prior-year period, driven by strong traffic trends, reduced promotions, and new launches. In addition to impressive growth in core intimates, the company has seen strength in apparel and activewear. 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 double-digits 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 60 to 75 openings planned for FY 2019.

3. Direct Business

AEO’s digital sales were strong in Q1 2019 and increased to 30% of total revenue for the period - an increase of 100 basis points from prior-year quarter. 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 2018, 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 marginally decline before stabilizing as a result of lower merchandise margins, increased promotions, partially offset by investments undertaken to improve margins in the digital space, including automation of the pick and pack processes in the distribution centers and implementation of a shipping optimization software.

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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 235 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 18th consecutive quarter of double-digit comps in Q1 2019, at 14%, building on the 38% seen in the prior year period, driven by strong traffic trends, reduced promotions, and new launches. In addition to impressive growth in core intimates, the company has seen strength in apparel and active 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 double-digits 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 60 to 75 openings planned for FY 2019.

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 28% of the company's overall revenues in FY 2018. 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 glamour.

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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