Why American Eagle Shares Dropped

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of American Eagle Outfitters (NYSE: AEO  ) were getting their wings clipped today, falling as much as 12% after the company posted a disappointing earnings report.

So what: Following a preliminary warning a couple of weeks ago, shares dove today as the teen fashion retailer reported adjusted earnings per share of $0.10, in line with its preannouncement and analyst estimates. Revenue slipped 1.7% to $727.3 million, better than the adjusted consensus at $719 million, while same-store sales sank 7%. What really seemed to kill the stock was third-quarter EPS guidance coming in at just $0.14 to $0.16, with a similar decline in comparable sales. Even after reducing estimates two weeks ago, analysts were expecting a $0.35 per-share profit as the back-to-school season tends to lift American Eagle sales.

Now what: The guidance cuts indicate that management doesn't expect to escape its present funk anytime soon. In fact, CEO Robert Hanson said that disappointing traffic trends have continued into the third quarter due in part to heavy competition. American Eagle's cost equation also dramatically worsened in the quarter, with cost of sales increasing despite the revenue drop, and gross margin dropped with 360 basis points. With all of these red flags in the report, I wouldn't get behind American Eagle until management stops this steep slide.

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