Why Did American Eagle’s Stock Fall Despite An Impressive Fourth Quarter?

by Trefis Team
American Eagle Outfitters
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American Eagle Outfitters (NYSE:AEO) posted a strong fourth quarter, meeting investor expectations on earnings, and beating revenue estimates by $20 million. The apparel retailer also provided a first quarter guidance for earnings per share of $0.20 to $0.22, coming in higher than consensus expectations of $0.19. The sales growth in the quarter was driven by the inclusion of an additional week, a 20% improvement at its digital business, and a comparable sales growth of 8%, including a 5% increase at its namesake brand and a staggering 34% at Aerie. So then why did the stock price fall 9% in the aftermath of the earnings release? Investors were probably not entirely convinced that the top-line growth was a result of brand strength, as a higher promotional stance adopted by the company could also be a major factor driving the sales improvement. The excessive discounting was also one of the reasons for a gross margin contraction, which fell to 34.6% in the quarter, below expectations of 35%, and 80 basis points lower than in the corresponding quarter of last year.

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Strength Of The Aerie Brand

American Eagle’s lingerie and activewear brand, Aerie, has gone from strength to strength, driving sales growth for the company. It posted a 15th consecutive quarter of positive comps in Q4, at 34%, building on the 17% seen in the prior year period. This figure is all the more impressive when compared to the growth figures delivered by its competitors. While the brand is much smaller in terms of sales when contrasted with Victoria’s Secret, the latter posted a comps decline of 1% in Q4. 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 has been growing at a tremendous rate.

Aerie’s strength lies in its body positive campaigns that resonate well with consumers. In 2017, the brand generated over 8.5 billion media impressions, a 28% increase in social media followers, and a double-digit growth in its customer base. 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, its 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.

Opportunity Exists For Margin Expansion

As mentioned earlier, American Eagle reported a drop in its gross margin rate as a result of the increase in promotions, higher shipping costs, and a rise in compensation. While the gross margin continued to slide throughout the year, the rate of deceleration improved as the year carried on, with the 270 basis points of gross margin erosion in the first quarter reduced to 80 basis points in Q4.

The fourth quarter of a financial year, or the holiday quarter, tends to be the most promotional quarter, with a majority of mall-based stores jostling for the increased sales activity undertaken by consumers. The company followed this strategy to gain market share, and to carry the momentum into spring. The company expects the sequential improvement in margins to continue in FY 2018, which could imply that the gross margin in Q1 2018 could actually be higher than that in the corresponding quarter of FY 2017. This is expected to be driven by reduced discounting, and 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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