“On Fire” Aerie Drives American Eagle’s Stellar Performance In The First Quarter

by Trefis Team
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American Eagle Outfitters
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American Eagle Outfitters‘ (NYSE:AEO) 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.

We have a $20 price estimate for American Eagle, which is lower than the current market price. The charts have been created using our new, interactive platform. You can click here to modify the different drivers, and arrive at your own price estimate for the company.

1. Impressive Jeans Performance: A significant amount of market share in the jeans market is up for grabs as a result of bankruptcies and store closures in the apparel retail space in the U.S. According to Statista, AEO’s market share was approximately 3.7% in the 2010-2015 time period. However, as per an update provided by the company, its share has risen to 7% by brand and by retailer. Moreover, the company is the second biggest denim retailer in the country, and in the 15 to 25 age group among specialty jeans, American Eagle jeans occupy the top spot with a 31% market share. There is scope for further improvement in this metric as more and more retailers fall prey to bankruptcies. In the first quarter, the company delivered its 19th straight quarter of record jeans sales, with further growth expected in the second quarter given the advent of the back-to-school season.

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 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. Growth of Digital Segment: 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.

4. Opportunity for Margin Expansion: While the gross margin continued to slide throughout 2017, as a result of the increase in promotions, higher shipping costs, and a rise in compensation, 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 company had anticipated the sequential improvement in margins to continue in FY 2018, and consequently, we had expected the gross margin in Q1 2018 to be higher than that in the corresponding quarter of FY 2017. AEO was able to deliver on this, with the gross margin rate increasing 50 basis points in the quarter. This was 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. AEO has guided for an improvement in the metric for the second quarter as well, which implies that the improved consumer confidence will continue to reduce the need for higher promotions.

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