American Eagle Still Flying (Fool Plate Special) August 19, 1999

An Investment Opinion

American Eagle Still Flying

By Louis Corrigan (TMF Seymor)
August 19, 1999

Casual apparel retailer American Eagle Outfitters (Nasdaq: AEOS) has "taken flight, and it shows no signs of landing." That's what I wrote last December about this company that now operates 426 stores in 43 states. It's what I might have written about the company a year and half earlier if I had been smart enough. And it's what ought to be said today, despite the combination of higher interest rates and the company's enormous same-store sales hurdles that have helped attract short-sellers to this high P/E retailer.

Last night, the company released second quarter earnings that were, predictably, well ahead of even the ever-rising expectations on Wall Street. Net sales chalked up a 42.0% gain to $178.6 million on a 19.8% comp-store sales increase for the quarter, ended July 31. Net income aired out a 77.4% gain to $16.9 million while earnings per share (EPS) shot up 75% to $0.35 from just $0.20 a year ago. The Street was looking for just $0.31 per share.

Unfortunately, American Eagle (AE) doesn't offer any other income or balance sheet data in its press release. Yet, year-to-date, sales are up 43.7% to $324.0 million on a 23.2% gain in same-store sales, and earnings per share (EPS) have risen 87.5% to $0.60 per share.

The quick read here is that sales overall have been booming, and sales at stores open for more than a year just continue to grow at an incredibly robust rate. That produces operating efficiencies that translate into rising margins and improved return on equity (ROE). According to Market Guide, ROE stood at 46.3% even before the latest numbers came in.

Though the stock was up $7/8 to $38 7/16 late this morning, that gain came only after a bounce off an early morning low of $35. Retailers can be hurt badly by an economic slowdown. And between rumblings of at least one more Fed rate hike this year and a stalled stock market, some of the joie de vivre that's kept consumers spending freely could be dampened over the next few months. All you have to do is consult last year's July through October stock charts for the major apparel retailers to see how kindly the market reacts to fears of rate hikes, recession, or both. Moreover, even well off its high of $52 3/8, American Eagle trades for about 24 times the current high-side earnings estimate of $1.58 per share for the year ending next January. And that estimate assumes 40% earnings growth this year.

The astonishing same-store sales gains of the past two years also reinforce the skepticism, and help explain why 2.4 million shares of AE had been shorted as of July. Even dynamic apparel retailers like the Gap (NYSE: GPS) have faltered after running up against difficult year-over-year comparisons. That's because a great period today means you've raised the bar next year. The short-sellers are looking out at AE's upcoming comp-store comparisons for the rest of the current FY99:

August 1998           +28.4%
September 1998        +23.7%
October 1998          +37.8%
November 1998         +24.8%
December 1998         +20.9%
January 1999          +33.5%

Given that these gains followed up on robust comps for the prior year, the shorts are right to take notice. Then again, consider how AE has done so far this year in leaping over FY98 comps:

Same-store sales         FY98         FY99
February                +40.7%       +32.7%
March                   +42.5%       +33.1%
April                   +79.0%       +16.9%
May                     +46.4%       +18.7%
June                    +26.4%       +26.3%
July                    +37.7%       +13.5%

Surely, the monthly same-store sales gain will not remain in double-digits indefinitely. But there's nothing yet in these numbers that suggests AE is having trouble finding new ways to manage its merchandise and brand to generate more sales.

Indeed, AE seems to occupy a sweet spot in the apparel market by offering a crowd of 16- to 34-year-olds modestly fashionable casual apparel, accessories, and footwear at value-oriented prices. So while its prices fall somewhere between the Gap and Old Navy, its overall stylings and brand more closely resemble Abercrombie & Fitch (NYSE: ANF), which has been one of the best-branded, highest performing specialty apparel retailers of the last couple of years. In fact, Abercrombie was so worried, it actually sued AE for knocking off its merchandise, image, and marketing. An Ohio court dismissed the lawsuit with prejudice last month.

Investors ought not dismiss American Eagle in the same fashion.