Can American Eagle Soar in the Long Run?

Apparel retailer American Eagle Outfitters (NYSE: AEO  ) ended its most recent fiscal year on a sour note amid tough conditions in the retail sector. In addition, American Eagle's management issued a weak outlook for the first quarter, sending the stock close to its 52-week low.

American Eagle's troubles are nothing new, as fellow players Abercrombie & Fitch (NYSE: ANF  ) and Urban Outfitters (NASDAQ: URBN  ) have also been struggling for a variety of reasons. However, can American Eagle emerge from its troubles? Let's find out.

In a sticky situation
American Eagle's acting CEO Jay Schottenstein summarized the company's problems and comeback efforts very neatly:

The past year has been tough and we are very disappointed with the company's financial results. The search for a new CEO is under way, yet in the meantime we are not standing still. We have aggressive near-term plans and excessive urgency to deliver improvements. 

But with American Eagle's poor results in the most recent quarter and a depressing outlook, investors are bound to be skeptical about the retailer's prospects.

American Eagle's revenue declined 7% to approximately $1 billion from about $1.1 billion last year. The fourth quarter had 14 weeks last year as compared to 13 weeks this year; but even then, comp sales were down 7%. A similar trend was seen throughout the year with annual revenue declining 5% to $3.3 billion from approximately $3.5 billion. The gross profit decreased 28% to $332 million amid increased promotional activity. 

Positive about the long run
So, the fourth-quarter numbers were pretty bad for American Eagle. But its long-term agenda looks promising with factory store expansion plans in the pipeline. This won't be easy, as the company saw declining mall traffic in the most recent quarter. Moreover, its merchandise assortments were inconsistent and were not in-line with customer expectations. As a result, American Eagle had to spend heavily on promotions, creating pressure on the margins.

But American Eagle has learned from its mistakes and understands the urgency to make improvements, stabilize, and strengthen its business. Although its in-store performance was bad, the retailer saw good online sales with brands such as Aerie getting solid traction internationally.

American Eagle is focusing on some specific opportunities for the near term, such as strengthening its product assortment. The company will focus on product innovation accordingly and capitalize on the strength and popularity of its core items like AE jeans or bottoms, Aerie undies, men's underwear, etc.  

Expansion moves
American Eagle is also investing in a new distribution channel and omnichannel projects; capital expenditures totaled $278 million last year. The retailer plans to open new distribution centers this summer, which will result in a single pool of inventory and greater efficiencies. In addition, American Eagle will expand internationally based on demand for its products; it will enter London this year. 

American Eagle opened 64 stores last year, including 39 new factory stores and 16 stores in Mexico. It also took ownership of its licensed stores in mainland China and Hong Kong. It closed 42 stores, including 29 Aerie locations. Overall internationally it added 23 licensed stores in 2013, ending the year with 66 stores in 12 countries.

It plans to continue this expansion in 2014 with planned capital expenditures of $230 million; the retailer also expects greater operational efficiency. For example, American Eagle sees markdowns increasing at a slower rate than in the prior quarters, which points toward margin improvements in the future.

A competitive space
American Eagle, however, faces tough competition from peers such as Abercrombie and Urban Outfitters; both are also looking to strengthen their businesses through different strategies. Abercrombie, for instance, is making strides in its online direct-to-consumer channel and will be making capital investments of $200 million this year to shore up its business. Abercrombie has experienced solid international growth, with same-store sales in China up 35% last year, and it is looking to carry the momentum forward this year as well. 

Urban Outfitters is also seeing solid growth in its Anthropologie and Free People brands...even though its namesake brand has fallen on tough times. Free People posted double-digit sales gains and a record operating profit in the most recent quarter; Anthropologie was also close to posting record results. Urban Outfitters is aggressively expanding its product assortment including shoes. This could attract more customers to its stores, leading to stronger competition. 

Bottom line
American Eagle fell behind expectations and has gotten off to an inauspicious start this year. However, the company expects gradual improvements in the business. Moreover, at a forward P/E ratio of just 14, American Eagle could prove to be a good investment in the long run if it executes its strategies successfully.

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