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Investment Overview for American Eagle Outfitters (NYSE:AEO)

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1. Latest Earnings Q2'20

American Eagle Outfitters reported a strong performance for the fiscal second quarter (ending July), with the company beating consensus estimates on earnings and revenues. Overall, American Eagle reported revenues of $884 million, down 15% y-o-y, while the company reported a loss of $0.08 per share, as compared to a profit of $0.38 per share in the year-ago period. However, the company's digital channel continued to flourish as digital demand surged by 48% despite the pandemic, with demand for Aerie's product swelling by more than 113%-resulting in Aerie's revenues growing by 32%. American Eagle didn't provide guidance for full-year 2020 due to uncertainty surrounding the impact of Covid-19.

2. Impact Of COVID-19

American Eagle stock has lost a bulk of its value since the outbreak of coronavirus. Moreover, the company has temporarily shuttered stores in the United States and Canada, as a result of continued measures to help slow the spread of COVID-19. The company has decided to furlough the majority of its store teams in the United States and Canada and is also planning to cut expenses across all operating heads. The company has also suspended its dividends and share repurchase program for the foreseeable future. Additionally, the company withdrew its earnings guidance provided after the release of its Q4 results (ending January), as it expects store closures and the impact of COVID-19 to have a material adverse impact on financial results.

3. 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 21st consecutive quarter of double-digit comps in Q4 2019, at 26%, building on the 23% seen in the year-ago 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 50 to 60 openings planned for FY 2020.

4. Direct Business

AEO’s digital sales were strong in FY2019 and increased to 29% of total revenue for the period - an increase of 100 basis points from the previous year. 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 over FY2013-2016, increasing from 10.9% in FY 2013 to 15% 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, over FY2017-2019, the metric underwent a decline, given the increasing shift to the online space, as well as a 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 217 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 21st consecutive quarter of double-digit comps in Q4 2019, at 26%, building on the 23% 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 50 to 60 openings planned for FY 2020.

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 FY 2019. The US apparel industry is gradually shifting towards omnichannel 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 omnichannel 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 omnichannel 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 shift its product portfolio from basic to fashion gradually 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. is 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 omnichannel platform

With e-commerce not turning into a big business for many retailers despite continued robust growth, the need for omnichannel 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 omnichannel 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 rollout was slow, but the company soon went aggressive on its deployment.

The retailer reported that its BOSS program 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, which 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 the online and mobile channels. It is in the process of adding new features to its website, including a 360-degree product view and an 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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