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 currently trades at $17 per share, around 56% below its level of $38 seen on April 25, 2021 (pre-inflation shock high), and has the potential for sizable gains. AEO saw its stock trading at around $9.73 at the end of October 2022, when the Fed kept increasing rates, and now remains up by about 72% from those levels. In comparison, the S&P 500 gained only about 6% during this period. AEO stock has benefited from better-than-expected fiscal first-half results. Despite flattish sales in the first two quarters of 2023, the retailer’s gross profit and operating income saw significant improvements – leading to a turnaround in earnings per share. With better inventory control and lower transportation and product costs, management achieved margin expansion thanks to fewer markdowns. That said, AEO’s gross margins in the fiscal first half came in at 37.7%, a large 680 basis points up year-over-year (y-o-y). Similarly, its operating margin during the same period came in at 5.4%, up from a mere 1.2% in the same period last year. AEO saw a profit of 25 cents per share in the first six months of FY’23 compared to a negative 24 cents in the same period last year.
Notably, AEO stock had a Sharpe Ratio of 0.3 since early 2017, which is lower than the figure of 0.6 for the S&P 500 Index over the same period. Compare this with the Sharpe of 1.2 for the Trefis Reinforced Value portfolio. Sharpe is a measure of return per unit of risk, and high-performance portfolios can provide the best of both worlds.
Returning to the pre-inflation shock level means that American Eagle Outfitters will have to gain about 120% from here. While it has the potential to recover to those levels, we estimate American Eagle Outfitters’ Valuation to be around $17 per share, almost in line with the current market price. It is important to keep an eye on freight rates as rising fuel costs could be a risk moving forward. Our detailed analysis of American Eagle Outfitters’ upside post-inflation shock captures trends in the company’s stock during the turbulent market conditions seen over 2022 and compares these trends to the stock’s performance during the 2008 recession.
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2022 Inflation Shock
Timeline of Inflation Shock So Far:
- 2020 – early 2021: Increase in money supply to cushion the impact of lockdowns led to high demand for goods; producers were unable to match up.
- Early 2021: Shipping snarls and worker shortages from the coronavirus pandemic continue to hurt the supply
- April 2021: Inflation rates cross 4% and increase rapidly
- Early 2022: Energy and food prices spike due to the Russian invasion of Ukraine. Fed begins its rate hike process
- June 2022: Inflation levels peak at 9% – the highest level in 40 years. S&P 500 index declines more than 20% from peak levels.
- July – September 2022: Fed hikes interest rates aggressively – resulting in an initial recovery in the S&P 500 followed by another sharp decline
- Since October 2022: Fed continues rate hike process; improving market sentiments help S&P500 recoup some of its losses
In contrast, here’s how AEO stock and the broader market performed during the 2007/2008 crisis.
Timeline of 2007-08 Crisis
- 10/1/2007: Approximate pre-crisis peak in S&P 500 index
- 9/1/2008 – 10/1/2008: Accelerated market decline corresponding to Lehman bankruptcy filing (9/15/08)
- 3/1/2009: Approximate bottoming out of S&P 500 index
- 12/31/2009: Initial recovery to levels before accelerated decline (around 9/1/2008)
AEO and S&P 500 Performance During 2007-08 Crisis
AEO stock declined from nearly $26 in October 2007 (pre-crisis peak) to $10 in March 2009 (as the markets bottomed out), implying that AEO stock lost almost 62% of its pre-crisis value. It recovered from the 2008 crisis to levels of around $17 in early 2010, rising roughly 74% between March 2009 and January 2010. The S&P 500 Index saw a decline of 51%, falling from levels of 1,540 in September 2007 to 757 in March 2009. It then rallied 48% between March 2009 and January 2010 to reach levels of 1,124.
AEO Fundamentals Over Recent Years
AEO revenues declined from around $4.3 billion in 2019 to about $3.8 billion in 2020, due to the impact of Covid-19. However, sales rose back to $5 billion in 2022, as demand picked up. Earnings per share declined from around $1.13 in 2019 to a loss of $1.26 in 2020, although it rose to about $0.69 in 2022. In 2022, inflation has curbed consumer spending and pushed up freight costs for the company, as well as supply chain challenges. Its Aerie brand has grown despite the macroeconomic environment, while its namesake brand has struggled with tough comparisons to its post-pandemic recovery.
With the Fed’s efforts to tame runaway inflation rates helping market sentiment, we believe AEO stock has the potential for strong gains once fears of a potential recession are allayed.
|S&P 500 Return||-1%||16%||99%|
|Trefis Reinforced Value Portfolio||-2%||29%||562%|
 Month-to-date and year-to-date as of 9/8/2023
 Cumulative total returns since the end of 2016
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