American Eagle Outfitters, Inc AEO
November 02, 2007 - 2:36pm EST by
mack885
2007 2008
Price: 22.50 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 4,800 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

All managers are self-interested, but some are more self-interested than others. Jay Schottenstein, American Eagle Outfitters, Inc.’s Chairman, is a consummate opportunist, and his actions nearly always signal share price movements and reward security analysis.  Schottenstein purchased 1 million shares of American Eagle, beginning the day after second quarter earnings were announced, at an average price of $24.06 (he owns over 6% of the company and family members own another 7.5%).  It is among the largest insider purchases in the retail industry in memory.

 

American Eagle is a mall-based apparel retailer, targeting 15-25 year-old women and men, but skewing younger. Denim is the business’ backbone, comprising approximately 20% of the company’s $3 billion in revenues. Its 800 stores average 5,700 gross square feet, a portion of which typically includes offerings from its new “aerie” concept, which sells underwear, sleepwear and dormwear to 15-25 year-old women and competes with Victoria’s Secret’s Pink.  The company has begun opening stand-alone, 3,000 square-foot aerie stores, and management believes it will open 60 stores in 2008 and that the brand can achieve $1 billion in revenues within five years. A third concept, Martin + Osa, which targets 28-40 year-old women and men under-served by department stores with a “refined casual” look (J. Crew meets Banana Republic), was launched in 2007 and is not yet profitable.  Although the American Eagle store concept is relatively mature in the U.S., international expansion remains and the aerie concept achieves returns on capital similar to American Eagle in a smaller store format (3,000 square feet).  Company-wide square footage is projected to increase over 10% in 2008.

 

The company is valued at only 6.2x 2007 EBIT and 9.5x 2007 earnings, net of the company’s $3.50 in cash per share. Furthermore, if one assumes that Martin + Osa will be closed if it is not value enhancing and its $0.16 per share loss is eliminated, then the company is being valued at only 5.7x 2007 EBIT and 8.8x earnings.  American Eagle has a repurchase authorization for over 10% of its shares.  Since the beginning of 2005, the company has repurchased approximately 25 million shares, representing more than 10% of the current shares outstanding, with almost one-half of the dollar amount being done during the last six months.  American Eagle could repurchase almost 15% of its shares with its remaining cash on hand.

 

American Eagle enjoys extraordinary margins, relatively low working capital requirements and high returns on capital.  Operating margins have averaged 20% over the last four years. Stores cost $730,000 to open, including $100,000 of inventory and all pre-opening costs, and return $525,000 in “four-wall” profits (which exclude allocated costs such as headquarters and distribution) or 72% in the first year before taxes.  Vendor financing increases first year returns to approximately 78%, before landlord incentives, gift cards and other zero-cost financing are considered.  Moreover, four-wall profit increases 17% per annum to $970,000 four years after opening.  These high returns on incremental capital at the store level are mirrored at the corporate level. Company-wide after-tax returns on average tangible capital exceeded 100% during the last two fiscal years.

 

American Eagle competes primarily against Abercrombie & Fitch Co. and Aeropostale, Inc., and while their merchandise is similar in style if not in quality, each employs very different pricing and promotion strategies and their stores offer markedly different customer experiences. It is widely believed that Abercrombie is the fashion leader and that American Eagle and Aeropostale follow.  However, all three companies design their merchandise based on European trends and place orders with suppliers at the same time.  What distinguishes Abercrombie, instead, is their typical price point, or “average unit retail” (AUR), which is approximately $35.  This AUR is substantially above American Eagle’s at $20, which is higher than Aeropostale’s undisclosed AUR.  Although merchandise may appear superficially similar at the three concepts, the AUR differential can be explained by differences in fabric weight and detailing. Abercrombie is also distinguished by its “club” store experience—it does not use its store windows for display, but instead covers them with blinds to distinguish between those who are “in” and those who are “out”, lights are dim and, semi-clad, live models greet customers at the entrance.  The American Eagle brand relies on a similar “club” association with its customers, and management believes this is critical to avoid price-based competition. Aeropostale, by contrast, is a “price point business,” meaning that merchandise is displayed on tables or racks with a particular price point—“$14.99”—displayed on signage that is intended to draw traffic into the store and stimulate purchases.  In addition, Aeropostale drives traffic with markdowns, frequently offering 50% off on entire categories such as hoodies or sweatpants or both.

 

American Eagle, like any large apparel retailer, may be sensitive to an economic downturn. In what has been a difficult retailing environment this year, comparable store sales have increased approximately 4%.  However, its Southern California and Florida stores are underperforming the rest of the store base, probably reflecting relatively worse housing price deflation. It could be argued that American Eagle’s lower AUR makes it less susceptible to margin pressure than Abercrombie, although this remains to be seen.  Management argues they expect to sustain margins, even during the current unsettled economic environment, as a result of lower transportation costs from increased sea shipping and better markdown performance from software that bases merchandise orders on size profiles by location and, when sales are less than expected, optimizes markdowns by considering regional differences in inventory.  In addition, management has shown an ability to control costs, with SG&A expenses as a percentage of sales declining over the last several years.

Catalyst

--Continued share repurchases
--Success of aerie
    sort by    

    Description

    All managers are self-interested, but some are more self-interested than others. Jay Schottenstein, American Eagle Outfitters, Inc.’s Chairman, is a consummate opportunist, and his actions nearly always signal share price movements and reward security analysis.  Schottenstein purchased 1 million shares of American Eagle, beginning the day after second quarter earnings were announced, at an average price of $24.06 (he owns over 6% of the company and family members own another 7.5%).  It is among the largest insider purchases in the retail industry in memory.

     

    American Eagle is a mall-based apparel retailer, targeting 15-25 year-old women and men, but skewing younger. Denim is the business’ backbone, comprising approximately 20% of the company’s $3 billion in revenues. Its 800 stores average 5,700 gross square feet, a portion of which typically includes offerings from its new “aerie” concept, which sells underwear, sleepwear and dormwear to 15-25 year-old women and competes with Victoria’s Secret’s Pink.  The company has begun opening stand-alone, 3,000 square-foot aerie stores, and management believes it will open 60 stores in 2008 and that the brand can achieve $1 billion in revenues within five years. A third concept, Martin + Osa, which targets 28-40 year-old women and men under-served by department stores with a “refined casual” look (J. Crew meets Banana Republic), was launched in 2007 and is not yet profitable.  Although the American Eagle store concept is relatively mature in the U.S., international expansion remains and the aerie concept achieves returns on capital similar to American Eagle in a smaller store format (3,000 square feet).  Company-wide square footage is projected to increase over 10% in 2008.

     

    The company is valued at only 6.2x 2007 EBIT and 9.5x 2007 earnings, net of the company’s $3.50 in cash per share. Furthermore, if one assumes that Martin + Osa will be closed if it is not value enhancing and its $0.16 per share loss is eliminated, then the company is being valued at only 5.7x 2007 EBIT and 8.8x earnings.  American Eagle has a repurchase authorization for over 10% of its shares.  Since the beginning of 2005, the company has repurchased approximately 25 million shares, representing more than 10% of the current shares outstanding, with almost one-half of the dollar amount being done during the last six months.  American Eagle could repurchase almost 15% of its shares with its remaining cash on hand.

     

    American Eagle enjoys extraordinary margins, relatively low working capital requirements and high returns on capital.  Operating margins have averaged 20% over the last four years. Stores cost $730,000 to open, including $100,000 of inventory and all pre-opening costs, and return $525,000 in “four-wall” profits (which exclude allocated costs such as headquarters and distribution) or 72% in the first year before taxes.  Vendor financing increases first year returns to approximately 78%, before landlord incentives, gift cards and other zero-cost financing are considered.  Moreover, four-wall profit increases 17% per annum to $970,000 four years after opening.  These high returns on incremental capital at the store level are mirrored at the corporate level. Company-wide after-tax returns on average tangible capital exceeded 100% during the last two fiscal years.

     

    American Eagle competes primarily against Abercrombie & Fitch Co. and Aeropostale, Inc., and while their merchandise is similar in style if not in quality, each employs very different pricing and promotion strategies and their stores offer markedly different customer experiences. It is widely believed that Abercrombie is the fashion leader and that American Eagle and Aeropostale follow.  However, all three companies design their merchandise based on European trends and place orders with suppliers at the same time.  What distinguishes Abercrombie, instead, is their typical price point, or “average unit retail” (AUR), which is approximately $35.  This AUR is substantially above American Eagle’s at $20, which is higher than Aeropostale’s undisclosed AUR.  Although merchandise may appear superficially similar at the three concepts, the AUR differential can be explained by differences in fabric weight and detailing. Abercrombie is also distinguished by its “club” store experience—it does not use its store windows for display, but instead covers them with blinds to distinguish between those who are “in” and those who are “out”, lights are dim and, semi-clad, live models greet customers at the entrance.  The American Eagle brand relies on a similar “club” association with its customers, and management believes this is critical to avoid price-based competition. Aeropostale, by contrast, is a “price point business,” meaning that merchandise is displayed on tables or racks with a particular price point—“$14.99”—displayed on signage that is intended to draw traffic into the store and stimulate purchases.  In addition, Aeropostale drives traffic with markdowns, frequently offering 50% off on entire categories such as hoodies or sweatpants or both.

     

    American Eagle, like any large apparel retailer, may be sensitive to an economic downturn. In what has been a difficult retailing environment this year, comparable store sales have increased approximately 4%.  However, its Southern California and Florida stores are underperforming the rest of the store base, probably reflecting relatively worse housing price deflation. It could be argued that American Eagle’s lower AUR makes it less susceptible to margin pressure than Abercrombie, although this remains to be seen.  Management argues they expect to sustain margins, even during the current unsettled economic environment, as a result of lower transportation costs from increased sea shipping and better markdown performance from software that bases merchandise orders on size profiles by location and, when sales are less than expected, optimizes markdowns by considering regional differences in inventory.  In addition, management has shown an ability to control costs, with SG&A expenses as a percentage of sales declining over the last several years.

    Catalyst

    --Continued share repurchases
    --Success of aerie

    Messages


    SubjectNew Writeup
    Entry11/02/2007 02:37 PM
    Membermack885
    Description:

    All managers are self-interested, but some are more self-interested than others. Jay Schottenstein, American Eagle Outfitters, Inc.’s Chairman, is a consummate opportunist, and his actions nearly always signal share price movements and reward security analysis.  Schottenstein purchased 1 million shares of American Eagle, beginning the day after second quarter earnings were announced, at an average price of $24.06 (he owns over 6% of the company and family members own another 7.5%).  It is among the largest insider purchases in the retail industry in memory.

     

    American Eagle is a mall-based apparel retailer, targeting 15-25 year-old women and men, but skewing younger. Denim is the business’ backbone, comprising approximately 20% of the company’s $3 billion in revenues. Its 800 stores average 5,700 gross square feet, a portion of which typically includes offerings from its new “aerie” concept, which sells underwear, sleepwear and dormwear to 15-25 year-old women and competes with Victoria’s Secret’s Pink.  The company has begun opening stand-alone, 3,000 square-foot aerie stores, and management believes it will open 60 stores in 2008 and that the brand can achieve $1 billion in revenues within five years. A third concept, Martin + Osa, which targets 28-40 year-old women and men under-served by department stores with a “refined casual” look (J. Crew meets Banana Republic), was launched in 2007 and is not yet profitable.  Although the American Eagle store concept is relatively mature in the U.S., international expansion remains and the aerie concept achieves returns on capital similar to American Eagle in a smaller store format (3,000 square feet).  Company-wide square footage is projected to increase over 10% in 2008.

     

    The company is valued at only 6.2x 2007 EBIT and 9.5x 2007 earnings, net of the company’s $3.50 in cash per share. Furthermore, if one assumes that Martin + Osa will be closed if it is not value enhancing and its $0.16 per share loss is eliminated, then the company is being valued at only 5.7x 2007 EBIT and 8.8x earnings.  American Eagle has a repurchase authorization for over 10% of its shares.  Since the beginning of 2005, the company has repurchased approximately 25 million shares, representing more than 10% of the current shares outstanding, with almost one-half of the dollar amount being done during the last six months.  American Eagle could repurchase almost 15% of its shares with its remaining cash on hand.

     

    American Eagle enjoys extraordinary margins, relatively low working capital requirements and high returns on capital.  Operating margins have averaged 20% over the last four years. Stores cost $730,000 to open, including $100,000 of inventory and all pre-opening costs, and return $525,000 in “four-wall” profits (which exclude allocated costs such as headquarters and distribution) or 72% in the first year before taxes.  Vendor financing increases first year returns to approximately 78%, before landlord incentives, gift cards and other zero-cost financing are considered.  Moreover, four-wall profit increases 17% per annum to $970,000 four years after opening.  These high returns on incremental capital at the store level are mirrored at the corporate level. Company-wide after-tax returns on average tangible capital exceeded 100% during the last two fiscal years.

     

    American Eagle competes primarily against Abercrombie & Fitch Co. and Aeropostale, Inc., and while their merchandise is similar in style if not in quality, each employs very different pricing and promotion strategies and their stores offer markedly different customer experiences. It is widely believed that Abercrombie is the fashion leader and that American Eagle and Aeropostale follow.  However, all three companies design their merchandise based on European trends and place orders with suppliers at the same time.  What distinguishes Abercrombie, instead, is their typical price point, or “average unit retail” (AUR), which is approximately $35.  This AUR is substantially above American Eagle’s at $20, which is higher than Aeropostale’s undisclosed AUR.  Although merchandise may appear superficially similar at the three concepts, the AUR differential can be explained by differences in fabric weight and detailing. Abercrombie is also distinguished by its “club” store experience—it does not use its store windows for display, but instead covers them with blinds to distinguish between those who are “in” and those who are “out”, lights are dim and, semi-clad, live models greet customers at the entrance.  The American Eagle brand relies on a similar “club” association with its customers, and management believes this is critical to avoid price-based competition. Aeropostale, by contrast, is a “price point business,” meaning that merchandise is displayed on tables or racks with a particular price point—“$14.99”—displayed on signage that is intended to draw traffic into the store and stimulate purchases.  In addition, Aeropostale drives traffic with markdowns, frequently offering 50% off on entire categories such as hoodies or sweatpants or both.

     

    American Eagle, like any large apparel retailer, may be sensitive to an economic downturn. In what has been a difficult retailing environment this year, comparable store sales have increased approximately 4%.  However, its Southern California and Florida stores are underperforming the rest of the store base, probably reflecting relatively worse housing price deflation. It could be argued that American Eagle’s lower AUR makes it less susceptible to margin pressure than Abercrombie, although this remains to be seen.  Management argues they expect to sustain margins, even during the current unsettled economic environment, as a result of lower transportation costs from increased sea shipping and better markdown performance from software that bases merchandise orders on size profiles by location and, when sales are less than expected, optimizes markdowns by considering regional diffe
    Catalyst: --Continued share repurchases --Success of aerie


    SubjectNew Concepts
    Entry11/04/2007 05:35 AM
    Memberspence774
    Thanks for the post. Knowing that each management team is different, do you have any data on the success rate for launching new brands in this space? I am under the impression that it rarely works, but don't know for sure. How do you think about this, and how long a test, or size of roll-out do you think is needed to determine success or failure?


    Subjectadditional 2 cents on new conc
    Entry11/05/2007 01:36 PM
    Membermpk391
    looking at the retail clothing universe from 1997 onwards, i counted about 20 new concepts with enough history that one could dub them either successful or failures.

    i counted 13 successes, (65%) which i guess was higher than i had expected. the 7 failures had either been shuttered or were still performing marginally.

    interestingly, new concepts seem to do well early on, or not at all. the early results and the pace of the store rollout would have been good indicators for this sample group. shuttered concepts usually ended in about 2 years. i agree with the comment that Schottenstein is likely to kill any concept that turns into a quagmire.

    so this would suggest curtains for M+O. as for aerie, i guess i don't know. i would have said it's looking good, but that feedback on the survey of store managers sounded concerning. i have felt that the pace of the aerie rollout is a bit too aggressive. maybe if they slowed down a bit?


    Subjecttbzeej
    Entry11/05/2007 06:49 PM
    Membermpk391
    thanks for the info. to be clear, i have no macro forecast here. i was just trying to point out the non-cyclical improvements have been made at AEO - ie, they're better prepared to weather a softening of demand than they were 4 years ago (other things equal!!).

    whatever the label, 2003/4 were tougher times than the late-90s/2000 and 2004+ periods for most specialty clothing retailers in the US. comps were generally weaker and margins were generally a lot lower

    I'll readily concede that 2001 or thereabouts was a milder downturn than 90/91, '82, '74, etc. and we COULD see tougher times than 2001.

    Subject'comfortable' inventory mix
    Entry11/10/2007 10:40 AM
    MemberSpocksBrainX
    guess we'll find out soon enough, but the above sure seems like a synonym for it could be high - otherwise, they would have just said it was lower; note that Q2 inventory was up 7% on a sqft level

    on earnings, note that they did a +2% comp for the quarter and still will see lower margins, so the lesson is that "recent expectations", words they used in the latest press release, can change on a dime. I for one think that if they get -5% comps or -7% comps which seems entirely possible that margins are going to be overwhelmed. Why would they be? Everything has worked for AEO in recent years. Of course, closing MO will help, but as has already been noted expanding stores does nice things in an upturn but magnifies bad news when it comes.

    Still, given free cash flow here AEO remains an intriguing story


    just 2c


    Subjectnew concepts
    Entry11/27/2007 05:55 PM
    Membergocanucks97
    i am curious if u can provide the list you come up with. off the top of my head, i can count over 10 failures over the last 5 years. feels like success rate is lower than 50%.

    Duds: Janeville, Forth & Towne, Thousand Steps, DEMO, Fitigue, Mish Mash, Diva London, Lillie Rubin.

    Marginal: Jimmy'Z, Soma, M+O, Ruehl, BEBE Sport, Arden B, Torrid, Acorn, AJ Wright, DD's Discounts...

    SubjectA few questions
    Entry02/07/2008 09:48 AM
    Membermickey203
    Thanks for the write-up. A general concern I have is that this company seems to be trying to force square footage growth where maybe the opportunities really don't exist - not a good strategy in any environment, but a very risky one now.

    To this point, how close is the American Eagle concept to saturation? 850 stores seems like a lot for a mid-price point concept yet they still seem to be pushing the unit growth. Do you have any sense for returns on these new units relative to existing units?

    Also, how comfortable are you with the pace of the aerie rollout? I know that they have some experience with selling the product in AE stores, but to go from a one-year test of 3 stand-alone stores to a 100+ rollout over 2 years seems very aggressive. I think there is still uncertainty around the product - even though they have sold pajamas, etc. for a while they just started selling bras recently and this is a very hard category to get right. Sounds like they are also adding a lot of new categories (beauty, etc.) that are unproven. Even if the product is right, should they not take some more time to make sure they have the real estate strategy right?

    On a different note, what are your expectations for capex in 2009 and beyond? Has been a huge ramp the last couple years and they are spending well in excess of D&A even though they are only projecting 10% square footage growth. I know they have had some IT spend, DCs, etc. which I assume goes away. Does capex get back to the $100ish range?

    Thanks.


    SubjectRecent Announcement
    Entry07/02/2008 03:22 PM
    Memberpman908
    Any thoughts on the CMO leaving? A this price, the stock seems cheap to me even if margins return to trough levels
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