Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
American Eagle Outfitters (NYSE:AEO), the teen retailer famous for its American Eagle and Aerie clothing lines, had a bang-up quarter back in August, reporting double-digit sales growth and near triple the profits it earned in the second quarter of last year. The stock dropped 8% on the news, though, part of a precipitous decline in share price that's seen AE lose 27% of its value in the last two months.
However, that's all about to change, according to a new upgrade on American Eagle stock just out of megabank Citigroup.
Upgrading American Eagle stock
This morning, analysts at Citigroup awarded American Eagle Outfitters stock a "buy" rating and a new $27 price target. That's not even as much as American Eagle stock cost two months ago, but if Citi is right, it means the stock could still go up 28% over the next 12 months.
Why so high?
Why does Citigroup have such high hopes for American Eagle? The analyst starts off by pointing out what a low base AE stock is starting out from, "down [about] 30% since reporting 2Q earnings on 8/29," in a write-up covered on StreetInsider.com this morning. At today's share price ($21 and change), American Eagle stock sells for less than 15 times trailing earnings -- or about a 35% discount to the average P/E ratio on the S&P 500.
More than just a low share price, though, Citi says:
AEO has something that others don't -- one of the most attractive growth concepts in retail (Aerie). Aerie is taking market share in the lingerie market with consistent double digit comps and significant growth potential. And with the recent sell-off, we believe the market is not giving AEO the credit it deserves for Aerie.
Flip back a few pages to AE's second-quarter earnings report in August, and you can see why this has Citi so excited. In Q2, Aerie grew "comparable sales" (sometimes known as same-store sales) 27% year over year -- 20 points better than American Eagle's 7% comps growth. So, while Aerie isn't as big as American Eagle proper (there were 109 "Aerie stand-alone stores" at the end of last quarter, and 131 "Aerie side-by-side locations" versus 939 "American Eagle stores"), it's clearly the brand that is driving growth at American Eagle Outfitters as a whole these days.
Valuing the business
In Citi's view, Aerie alone would now be worth roughly $2 billion were it a stand-alone business -- making up more than half the value of American Eagle Outfitter's total market cap, despite accounting for fewer than one-quarter of the company's total store count. What's more, if you net out the value of Aerie, Citi says the rest of the American Eagle empire is being valued at just "3.1x EV/EBITDA, which we believe is overly pessimistic."
Is Citi right about that? I'll admit I'm not as good at "sum of the parts" business analysis as Citi probably is, but when I look at American Eagle Outfitters stock as a whole, I cannot help but agree with the analyst that we're looking at a pretty nice bargain, here.
Over the past 12 months, American Eagle has reported $258 million in GAAP earnings and generated even more impressive free-cash-flow numbers -- $309 million in FCF over the past year, according to data from S&P Global Market Intelligence, or about $1.20 in cash profit for every $1 in reported "earnings" under GAAP.
With so much cash being generated, American Eagle sports a pristine balance sheet with $363 million in cash and equivalents, but not a lick of debt. As a result, I value the business as a whole at a $3.7 billion market cap, minus $363 million in cash, equals barely $3.3 billion in total enterprise value -- or less than 11 times trailing free cash flow.
With most analysts in agreement that American Eagle will grow its profits at about 12% annually over the next five years, and the stock paying a 2.6% dividend yield on top of that, 11 times FCF seems like a very cheap price to pay for this high-quality retailer. American Eagle stock is a buy.