AEO - American Eagle Outfitters: A Tight Fit For Investors

2023-08-04 09:30:59 ET

Summary

• American Eagle Outfitters is a specialty apparel retailer with two core brands: American Eagle and Aerie.
• The stock has appreciated 22% in the past month but are only up 3% year-to-date, underperforming the broader market.
• The retailer pre-announced better-than-expected Q2-23 results, with stronger-than-expected results beginning in late June through July.
• Shares are valued at 13.5x our F2023 EPS estimate, providing limited near-term upside. We would be more constructive on the stock below $12.

Introduction

American Eagle Outfitters ( AEO ) is one of the few iconic apparel retailers for teens. While we have written articles across industries, our expertise is in the consumer discretionary sector, specifically retail. As a result, we are re-focusing our efforts on the retail industry for articles (although there may be some exceptions, within the "special situations" framework). The primary purpose of this article is to provide our perspective on AEO.

Company Overview

American Eagle Outfitters is a specialty apparel retailer primarily for teens with two core brands: American Eagle and Aerie.

American Eagle is casual apparel brand for jeans, bottoms, sweaters, fleece, tops, and accessories. At the end of Q1-2023, there were 867 stores.

Aerie is a lifestyle brand for intimates, cozy apparel, swimwear, and activewear. At the end of Q1-FY2023, there were 297 stores.

Stock Chart

During the past month, AEO shares have appreciated 22%, commensurate with the more positive sentiment towards consumer discretionary stocks. Nonetheless, year-to-date, the stock is up only 3%, relatively flat, and underperforming the broader market.

Leadership

A common theme in our approach to stock selection is an emphasis on strength of management and/or founder-led companies.

Jay Schottenstein is executive chairman and chief executive officer. While the Schottenstein family were not the founders of the American Eagle brand, they acquired Retail Ventures , which owned the American Eagle brand, in 1990. Schottenstein has been chairman of AEO since 1992 and has had multiple stints as chief executive officer, most recently returning in 2014 (after a 12-year hiatus). According to the most recent proxy statement , Schottenstein owns 6.3% of AEO, with 12.5 million shares. He is also the chairman of Designer Brands ( DBI ), formerly known as DSW.

We wouldn't "bet" against Schottenstein and think investors in AEO benefit tremendously from his visionary leadership.

Q2-23 Earnings Pre-Announcement

On Thursday, August 3, American Eagle Outfitters pre-announced Q2-F2023 results by raising expectations. In the press release, AEO increased revenue guidance to "approximately flat" from "down low-single digits" and stated that operating income would "exceed" the previous range of $25 million to $35 million. Management indicated demand "picked up" in late June and continued into July with the introduction of Fall collections.

We are encouraged by this incrementally positive news and think it's worthwhile to speculate as to the reasoning for the unusual mid-summer pre-announcement. Based on the retail reporting calendar, Q2-F2023 ended on Saturday, July 29. Therefore, AEO is in a "quiet period" until reporting second quarter results in September. We think AEO likely pre-announced results in anticipation of investor meetings during this period, and therefore elected to disclose this news to have more flexibility in communications.

Further, we think this pre-announcement could further mark an inflection point in business fundamentals and thereby profit margin expansion. Moreover, from a macro perspective, we suggest these strong results may foreshadow similarly strong results from other retailers, particularly those catering to less price sensitive consumers.

Retail Macro Perspective

While Q1-FY2023 results for American Eagle Outfitters were mixed, as we read the conference call script , there was a statistic that clearly indicated that fundamentals were beginning to improve: average unit retail (i.e. average price per item) was the second highest in the company's history and 20% higher than pre-pandemic across brands.

Based on management's commentary on that conference call, we also think there are strong opportunities for AEO to drive earnings growth based on operational efficiencies and reduced expenses. As a result, we think better-than-expected results in 2H:FY2023 may be generated by the dual effects of more resilient consumer spending combined with tighter expense management.

We don't think the resumption of student loan payments will have a materially negative effect on AEO. Simply put, the core customer for AEO are high school and college students, and therefore they do not have student loan bills. (Payments aren't due until after graduation.) Moreover, for those customers who do have loans, we think from a macro perspective, consumers will curb spending in other categories rather than apparel, especially women for which on-trend fashion is important.

Balance Sheet

At the end of Q1-FY2023, AEO held net cash of $87 million, after adjusting for a modest $30 million of debt. (We don't consider lease liabilities to be debt.) We think the approximate 10% decline in year-over-year inventory at the end of first quarter ($625 million versus $682 million) is indicative of stronger inventory management and likely a source of gross margin improvement this year.

AEO pays shareholders a quarterly dividend of $0.10, resulting in a current dividend yield of 2.7%. We think this return of shareholder capital makes the stock attractive to income-seeking investors (retail and institutional) and obviously contributes to total shareholder returns.

Valuation

We estimate that AEO will earn $1.10 in EPS for F2023, resulting in a current 13.5x forward P/E multiple.

In our view, the peer group for AEO includes: Abercrombie & Fitch ( ANF ), The Buckle ( BKE ), and Urban Outfitters ( URBN ). The forward P/E multiples based on FY2023 expectations for these stocks are: 22x for ANF, 9x for BKE, and 13x for URBN. The average multiple is 15x.

At 15x our F2023 EPS estimate, AEO would trade at $16.50, implying limited upside of approximately 10% and therefore a somewhat unfavorable risk/reward at the current valuation.

Catalysts

We suggest the primary near-term catalysts are: (1) better-than-expected guidance for 2H:FY2023; (2) increase to the quarterly dividend; and (3) aggressive share repurchase program. We think for guidance to be better-than-expected, AEO would need to experience sustained improvement in sales trends, particularly with more traffic and higher conversion rates.

Risks

We believe the key near-term risks are: (1) worsening macroeconomic trends which result in a reversal of recent positive trends; (2) loss of Jay Schottenstein as chief executive officer, especially given recently announced leadership changes ; and (3) suspension or reduction in the quarterly dividend.

Conclusion

American Eagle Outfitters is an exceptionally well-run specialty retail company with Jay Schottenstein as executive chairman and chief executive officer. For long-term investors, we think the stock can steadily appreciate, given improved consumer spending trends, more efficient operations, and stronger brand loyalty. Nonetheless, at more than 13x our F2023 EPS estimate, we simply think AEO shares have limited near-term upside with downside risk to the $10 to $12 range. As a result, we would wait for a pullback to below $12 before turning more positive on the stock. For investors who desire exposure to specialty retail stocks, we favor those with more compelling valuations, such as Chico's FAS ( CHS ), The Children's Place ( PLCE ), and The Cato Corporation ( CATO ).

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