After a 43% decline year-to-date (YTD), at the current price of around $14 per share, we believe American Eagle Outfitters (NYSE: AEO), which sells men’s and women’s apparel and accessories under the American Eagle, Tailgate, Todd Snyder, and Aerie brands – could see modest gains in the long term. AEO stock has declined from around $25 to $14 YTD, largely underperforming the broader indices, with the S&P falling about 19% over the same period. AEO’s stock decline can be attributed to its declining overall revenues, rising inventories, and shrinking gross margins. There is a link between these problems and inflation, which has curbed consumer spending and pushed up freight costs for the company, as well as supply chain challenges. Although the Aerie brand has grown despite the macroeconomic environment, its namesake brand has struggled with tough comparisons to its post-pandemic recovery. However, that pressure seems to have eased a little in the third quarter as its inventories rose at a slower pace and its gross margin expanded sequentially compared to the second quarter. It was encouraging to see AEO’s gross margin hold steady since it is still heavily reliant on markdowns to boost sales and reduce inventories.
In Q3, the apparel retailer’s revenue declined 3% year-over-year (y-o-y) to $1.24 billion, but still beat analysts’ estimates by $40 million. Aerie brand rose 11% and the American Eagle core brand fell a similar 11% y-o-y in Q3. Gross margins contracted to 38.7% from 44.3% in the prior year quarter as the company worked through bloated inventory levels. The markdowns helped bring inventory levels to within 8% of prior year levels, down from an over 36% y-o-y increase marked in Q2 2022. Its net income dropped 47% to $81 million, or $0.42 per share, which also beat the consensus forecast.
We have updated our model following the Q3 release. We forecast AEO’s Revenues to be $3.5 billion for the fiscal year 2022, down 1% y-o-y. Looking at the bottom line, we now forecast the earnings per share to come in at 86 cents. Given the changes to our revenues and EPS forecast, we have revised our AEO’s Valuation to $15 per share, based on a 86 cents expected EPS and a 17.5x P/E multiple for the fiscal year 2022 – almost 5% higher than the current market price.
AEO expects inventory clearing to support margins at the higher end of the previous guidance in the range of 32% to 33% in the fourth quarter. Additionally, the company remains on track to deliver $100 million in cost savings in the fourth quarter. It should be noted that AEO expects its Q4 revenue to be down in the mid-single-digits with comparable sales across brands consistent with the third quarter. This expectation is similar to its peer Gap’s (NYSE: GPS) recent guidance for a third-quarter sales decline in the mid-single-digits. The good news here is that AEO expects its inventories to decrease y-o-y in the fiscal fourth quarter. This would allow it to start fiscal 2023 with a clean slate and ease off its markdowns. To add to this easing, cotton prices and lower freight costs compared to the beginning of this year could likely help AEO stabilize costs in FY 2023. Overall, AEO’s success hinges on revitalizing its namesake banner with fresh products and aggressively expanding Aerie’s banner.
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While AEO stock looks poised for more gains in the future, it is helpful to see how its peers stack up. Check out how American Eagle Outfitters’ Peers fare on metrics that matter. You will find other valuable comparisons for companies across industries at Peer Comparisons.
With inflation rising and the Fed raising interest rates, AEO stock has fallen 43% this year. Can it drop more? See how low can AEO stock go by comparing its decline in previous market crashes. Here is a performance summary of all stocks in previous market crashes.
|S&P 500 Return||-5%||-19%||73%|
|Trefis Multi-Strategy Portfolio||-5%||-21%||216%|
 Month-to-date and year-to-date as of 12/22/2022
 Cumulative total returns since the end of 2016
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