Aerie Momentum Continues For American Eagle, Future Looks Bright Despite A Slightly Weak Guidance

by Trefis Team
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AEO
American Eagle Outfitters
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American Eagle Outfitters‘s (NYSE:AEO) stock fell in the aftermath of its third quarter earnings release which was likely a result of its weak earnings guidance for Q4 rather than Q3 performance. The company expects the earnings to come in between $0.40 and $0.42 per share ($0.07 of reduced earnings per share as a result of operating with one less week), based on comparable sales growth of mid-single-digits and revenue increase in the low single-digits. Though the apparel retailer posted strong comparable sales growth of 8% in Q3, driven by an impressive 32% increase in Aerie, it slightly missed on consensus estimates for revenue, but met the earnings expectations. It marked the 15th consecutive quarter of positive comps growth for AEO, with an increase reported both in the store comps (6%) and the digital segment (double-digit increase). 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 the company in the future, ensuring strong growth in the years to come.

We have a $25 price estimate for American Eagle, which is considerably higher than the current market price. The charts have been created using our new, interactive platform. You can click here for our interactive dashboard on American Eagle’s Performance In Q3 And Estimating Its Fair Price to modify the different drivers, and arrive at your own price estimate for the company.

Factors That May Impact Performance

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 third quarter, AE jeans continued to set record volumes, delivering its 21st consecutive quarter of positive comps, and best ever sales in both men’s and women’s bottoms.

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 16th consecutive quarter of double-digit comps in Q3 2018, at 32%, building on the 19% 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 70 openings planned for FY 2019.

3. Growth of Digital Segment: In Q3, AEO noted a 15th consecutive quarter of double-digit growth in its digital segment, with digital penetration expanding to 27% of revenue. 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 first quarter, 170 basis points in Q2, and 80 basis points in Q3, with flat or slightly improved gross margins expected in the fourth quarter. This has been driven by higher merchandise margins, rent leverage, reduced promotions, 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. We expect these trends to continue to drive an improvement in this metric, helping the company improve its earnings.

5. Lower Tax Rate: As a result of the lowering of the corporate tax rate in the U.S. from 35% to 21%, effective January 1, 2018, the apparel retailer can be expected to benefit substantially. The company has had an effective tax rate averaging 36% over the past five years. In FY 2018, we estimate the metric to be 24.4% for the company, resulting in a significant improvement in the net income margin.

 

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