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American Eagle Reports Solid, Underwhelming Quarter

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After pulling up sharply over the last week, American Eagle (NYSE: AEO  ) got knocked down 10% today after it reported earnings per share in line with the market's expectations. As I mentioned in my preview of the company's earnings, investors seemed to have overbuilt the success that the brand would have beyond the semi-official analyst estimations. That has lots of implications, but the most important is this: The announcement wasn't indicative of a failure, just of overhype.

The apparel retailer is in the early middle stages of a brand turnaround, with 2012 being a rousing success. Earnings and comparable sales are increasing, and management has laid down a clear path to growth that's not overly risky. In short, it wants to focus on the core brand in the U.S., cut back underperforming locations, open new domestic locations, and only then think about international expansion. American Eagle still looks like a good play, and the pullback today puts its price back in line with realistic expectations for the coming year.

The fourth quarter at American Eagle
American Eagle nailed its earnings expectation, which was in line with the market's expectation. Earnings per share rose 41% to $0.55 for the quarter and $1.39 for the year. The first reason that American Eagle failed to hit the high bar set by investors this week came down to comparable sales. While it grew comps by 4% in the quarter, it saw a slowdown from its reporting in January. At that time, sales were up 5%, with the company coming off a good holiday season. On the conference call this morning, CEO Robert Hanson said that mall traffic had been lighter than anticipated, which affected comparable sales. 

The second big reason the stock dropped was the company's less-than-stellar first-quarter outlook. It now expects comparable sales to fall in the first quarter. The company cited macroeconomic problems and bad weather as some of the biggest issues pushing it down. That shortfall in sales is then forecast to turn into a drop in earnings per share between 14% to 27%. Ouch.

So what is there to be excited about?
It's still not a bad time to look at American Eagle because I think management is being overly cautious. Investors have heard a lot about the economic headwinds, but most strong brands have been able to overcome those issues to keep selling. I never tire of the comparison between American Eagle and Gap (NYSE: GPS  ) . Gap has also undergone a brand turnaround, and the company is pushing its comparable sales up despite the economy.

In its earnings statement last week, Gap said that comps rose 5% in the previous quarter and that it expects to see modest growth this year as well. I think that American Eagle has put enough into the brand over the last year that it should see similar results. While comps dropped off over the past few months, I think they'll continue to be positive through the first quarter.

That's based on the company's plan to keep trimming back underperforming stores. Over the year, American Eagle plans to shut down between 15 to 20 underperforming stores that are dragging comps down. Assuming that those closures are front-loaded, they should have less impact on the comps this coming quarter. That, along with the strength of direct sales, which increased 24% last quarter, should be enough to keep investors happy.

The bottom line
While the outlook is subdued and the earnings missed unspoken expectations, I'm not worries about American Eagle just yet. While I keep comparing it to Gap, it's helpful to take a look at other competitors such as Aeropostale (NASDAQOTH: AROPQ  ) to round the view out. Aeropostale had a fall in comps over the holidays of 8%, which was stacked on a 9% decrease from the previous year. In calls and press releases, it's become clear that management has no meaningful plan for getting out of that hole. Compared to Aeropostale, American Eagle is saint-like.

Given the context of its competition and the success that American Eagle has had over the past year, I'm happy to keep watching as things improve. I still think Gap is the better overall play, but American Eagle isn't a bad choice, and with a P/E of 18, its cost is in line with the sector average. For investors looking to invest in an apparel retailer, American Eagle offers a very good chance at growth over the next three years.

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Read/Post Comments (4) | Recommend This Article (0)

Comments from our Foolish Readers

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  • Report this Comment On March 06, 2013, at 9:55 PM, Retailermaven wrote:

    I'm really doubting the analysts' credibility on this. American Eagle did not deliver last quarter, and this "brand turnaround" is nothing but talk so far. Anyone that's been paying attention to or works in the sector can see its been nothing but heavy promotions and well placed PR. Their international launches have been bust, and their fashion product hasn't been performing. The author credits them but slams Aeropostale for doing nothing when all I see from them are partnerships with Chloe Mortz, TeenVogue magazine, and significantly improved products left and right. The difference is they don't overpromise and end up shorting analyists' expectations. Personally, I would take ARO over AEO long.

    If you're looking for a retail darling, instead of American Eagle, I'd pull for Urban Outfitters if you want a solid bet that's not going to be a total letdown.

  • Report this Comment On March 07, 2013, at 10:21 AM, XMFRedRam wrote:

    Thanks for reading.

    If AEO is awash in promotions, then they certainly have an interesting way of recording the sales. Gross margins were up 210 basis points in the last quarter. The company also said it saw an increase in average selling prices, which makes widespread promotion -- e.g. discounting -- doubtful.

    The company's international plan is anemic right now, but with only 49 of its 1,000+ stores overseas, I can't see that it's really holding them back.

    ARO, on the other hand, is watching average transaction values drop and comparable sales fall. Partnerships are great PR, but if no one's buying then I can't see how it matters.

    Feel free to disagree, though.

    Cheers, Andrew

  • Report this Comment On March 07, 2013, at 9:40 PM, Retailermaven wrote:

    Thanks for the response Andrew, I appreciate your time.

    Of course Q4 went great for American Eagle, but that was due more to natural product mix than actual strategic planning: Outerwear & Gift novelties. These high-margin, low cost categories were able to boost overall transaction prices and margins, but even then, it was a failure.

    The consumer laughed in their faces at their initial offerings, think $80 puffer vests, and forced them to reneg at a more wallet-friendly price. A peek on their website now will still show interim markdowns on new product, mostly fashion-centered, which is not a good sign in a post-teen-prep world. Walk into any mall store, and you'll see t-shirts and shorts up front. Is this a sign of confidence in fashion?

    Internationally, both their opening in Mexico and the Philippines were a wash and drew little organic interest. Again, not a good sign for future expansion.

    ARO still has my vote for their burgeoning childrenswear extension, an outstanding price-to-sales, zero debt, and more-than-solid long-term top line growth, which with cotton prices rebounding, will boost the bottom as well. With a better mix of well-recieved fashion, public interest, and historically a parental favorite among teen retailers, I see end of summer and back-to-school being a slam dunk, granting spring to finish their brand and marketing transition.

    My apologies if my initial comment came off as a bit rude, I do see your insights as valuable, but there may be more below the surface.

  • Report this Comment On March 08, 2013, at 7:39 AM, XMFRedRam wrote:

    Thanks for the response. I'm willing to believe that the mood on the ground is shifting, and that ARO may have good things yet to come. I'll keep a closer eye on them from here on out.

    We'll check back in in three months and see what the next quarter brings.

    Cheers, Andrew

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