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1 Big Problem for This Popular Retailer

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Yesterday, teen apparel retailer American Eagle (NYSE: AEO  ) posted its first-quarter results. The company has struggled over the last year as it tries to find its niche. Recently, management has tried to shift from supplying just basics to a wider range of fashion items. Apparently, it hasn't caught on just yet.

Total sales in the reported quarter were down 4%, with comparable sales falling 5%. Along the way down the balance sheet, margins dropped and resulted in a drop in earnings per share, which came in at $0.18 compared to $0.22 last year. The company has a well-known brand and good store footprint, so what's the missing piece?

Subpar results from American Eagle
If there's a recurring theme with apparel retailers this year, it's how much the weather has affected the business. It's no surprise that American Eagle cited the long, cold winter as one of the main problems it faced this quarter. Target (NYSE: TGT  ) rolled out the same reasoning when it announced a less-then-stellar performance yesterday, citing weakness in weather-related apparel sales.

The difference at Target was that the company had other products to fall back on, so comparable sales only fell slightly, while they dove at American Eagle. Even with that fall, the market rewarded American Eagle yesterday. The stock rose slightly, though it gave up those gains in early trading today.

The problem American Eagle has is that it fails to keep up any of the momentum that it gains. Case in point: Last year at this time, American Eagle managed a 17% increase in comparable sales. A 22-percentage-point drop in comparable sales isn't just weather-related. American Eagle is losing out to trendier brands like Urban Outfitters (NASDAQ: URBN  ) . Urban managed a 9% increase in comparable sales last quarter. Sales rose because teens like the brand, and they're turning away from American Eagle.

Where's the shortfall?
If it's not weather, then where's the problem at American Eagle? I'd argue that it's at the management level. The company has failed to capture the trendy fashion market-share that it's been planning to attack for some time now. Core items still make up 40% to 45% of the company's sales, which means that the company is still relying heavily on those items.

The problem with that approach is that it pegs American Eagle as a basics company, and basics aren't fashionable. Looking at Urban Outfitters, as the other end of the spectrum, the company has managed to grow its Anthropologie line into an aspirational brand. Last quarter, the company not only improved sales but actually grew gross margin by more than a full percentage point, up to 36.8%. That's a reflection of brand strength, something that American Eagle lacks.

With more than 1,000 locations in the U.S. and strong brand recognition, American Eagle has the potential to jump on the trendy end of the fashion bandwagon, but management has to go for it. Right now, the company is playing to its historic strengths, and that means that it's going to keep repeating the past. I like American Eagle's potential, but I'm worried that management isn't ready to unlock it.

Should you take a chance on this struggling department-store stock?
J.C. Penney's stock cratered under Ron Johnson's leadership, but could new CEO Mike Ullman present the opportunity investors have been waiting for? If you're wondering whether J.C. Penney is a buy today, you're invited to claim a copy of The Motley Fool's must-read report on the company. Learn everything you need to know about JCP's turnaround -- or lack thereof. Simply click here now for instant access.

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Related Tickers

9/30/2016 4:01 PM
AEO $17.86 Up +0.14 +0.79%
American Eagle Out… CAPS Rating: ****
TGT $68.68 Up +0.96 +1.42%
Target CAPS Rating: ***
URBN $34.52 Up +0.09 +0.26%
Urban Outfitters CAPS Rating: ****