AEO - American Eagle Outfitters: Weaker Short-Term Top Line Estimates But Promising Investment

2023-05-29 04:09:56 ET

Summary

• The dynamic fashion industry has impacted many companies, calling for adaptability and innovation to survive.
• AEO has adopted solid and innovative ways that I believe have helped it survive the adversities in the industry.
• Using the regression model, the short-term financial prospects of the company are bleak, but I am very optimistic about the long-term view.

Investment Thesis

When investing in the fashion sector, a strong eye for spotting opportunities and trends is necessary. Finding a good investment opportunity might be challenging in today's dynamic retail climate. Traditional brick-and-mortar retailers have been impacted by e-commerce, and the Covid-19 pandemic has severely hurt the fashion industry.

These dynamics and challenges have significantly affected American Eagle Outfitters, Inc. (AEO). The company is still facing challenges related to macroeconomic factors, as seen by its financials, even though some of the changes have been accommodated through innovations. In this article, I'll employ a regression model to assess the company's topline prospects while accounting for economic factors. According to the model's output, the company's long-term growth levers are quite strong, but the macroeconomic conditions will limit its short-term prospects. Given this context, I have some reservations about the company's short-term viability, but the long-term prognosis appears bright, given the company's strong growth levers.

Long-term Growth Levers

Although the retail business as a whole, and the textile sector in particular, has been through challenging times straight from covid 19 to an inflationary environment, AOE has certain solid attributes that I feel enabled them to manage these adversities and which I believe stand to be the company's long-term growth levers.

1. Strong Brand Identity

AEO's compelling brand identity is a significant selling point for the company. The organization is well-known for producing reasonably priced fashionable garments , making it especially popular among college students and younger generations.

The brand has also set itself apart from rivals by developing innovative offerings, such as the Aerie line of intimate and loungewear for women. Aerie has shown remarkable revenue growth and has contributed to AEO's improved financial standing. To shed some light on this, consider that in Q1 2023, Aerie maintained its status as a customer favorite while posting record-breaking revenue and profits . In addition, Aerie has built a devoted following thanks to its emphasis on body positivity and diversity. The company's differentiated products and high brand loyalty make it a promising investment.

2. Multi-Channel Strategy

Due to its multi-channel approach, AEO stands out as a desirable investment. The company has an efficient and dependable online commerce system , and significant investments have been made by the company in their e-commerce infrastructure with the objective of offering their customers an effortless omnichannel shopping experience.

In navigating the challenges presented by the pandemic through innovative technology solutions like implementing curbside pickup options, the company's physical stores have been used successfully as regional distribution hubs allowing for faster and more cost-effective deliveries to customers.

3. Innovative Product Lines

The success of American Eagle Outfitters can be attributed to the company's unique product lines, as well as its strong brand identity and multi-channel approach. The company's Tailgate brand, which caters to rabid college sports fans on campus, has helped it maintain its popularity among younger clients and attract new ones.

They have also successfully launched their environmentally friendly Denim X brand, and they are working to adapt their product range to reflect ethical fashion trends. The company is well-positioned to address this demand as the fashion industry emphasizes sustainable fashion and eco-friendliness.

Revenue Projection: Economic Factors Consideration

Having mentioned that macroeconomic factors have impacted this company's financials, I ran a regression model to evaluate the interplay between the company's top line and some select factors. I used data from the last five years to do the analysis. In my model, my dependent variable was sales, and I regressed it against US GDP, CPI, and the apparel market size. First off is to account for the suitability of the variables in the model. On running correlation tests, the independent variables other than CPI positively correlated with sales, meaning that a positive incremental unit of each led to a positive incremental unit to the Y variable. The correlation was negative for CPI, indicating that as CPI goes up, the company's sales go down. These results make a lot of sense because we expect sales to increase as GDP and market size increase and then decrease marginally as inflation increases.

Secondly is to justify if the model is decent. With an R squared value of about 87%, consequently, this validates my model as a good one for the estimation. In addition, the P-values for the variables fall within the acceptable range for the confidence interval (less than 0.05), making them statistically significant. Below are the model's results, given this background.

Looking at the output of this model, the intercept and the coefficients are presented. Taking the intercept and the beta coefficients, then plugging the estimated values of the X as of 2023 in the model, and adding the standard error figure in the model summary, I arrived at annual revenue of about $4.89B, which is slightly lower than what they recorded in the previous financial year. These forecasts align with the company's most recent reduced revenue projections in light of the challenging macroeconomic considerations.

The most significant threat to this company's bottom line is the persistently high inflation and relatively weak economic growth due to the long-term effects of Covid 19 and the currently worrying inflations limiting and confining consumer expenditures on apparel. When considering the negative coefficient and the negative correlation of CPI to sales, the problem becomes apparent.

Although I recognize the short-term effects of these macroeconomic issues on the company, I tend to side with the neoclassical view that the economy will correct itself through flexible prices and wages. I anticipate a long-term new equilibrium, where prosperity and tranquility return to the company, and its top lines keep growing.

Valuation

AEO stock is trading at a PE of 18.82X with a forward PE of 11.73X; this lower forward PE ratio expresses the market's optimism for the company's future earnings. I believe this could be feasible after the current headwinds in the macroeconomy subsidize. Further, A DCF model by Finbox shows that the company trades below its fair value. The model estimates a fair value of $13.44, leaving the company with an upside potential of 25%.

Given its solid fundamentals, once the headwinds seize, I believe this is a good margin that the company will exploit.

Conclusion

Due to its solid brand recognition, diverse distribution channels, and cutting-edge product offerings, American Eagle Outfitters represents a promising business prospect. The retail giant has proven it can survive the hurdles provided by the pandemic and innovate its way to the top. Its continuous commitment to sustainability and eco-friendly fashion also bodes well for the company's expansion prospects. Investors seeking to diversify in the fashion business should take a look at AEO. Still, they must be patient because the current economic climate stifles the company's short-term financial prospects.

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