In a well-known challenging retail environment, one teen-focused company seems to be a potential bright spot. American Eagle Outfitters' (NYSE:AEO) management has shown consistent and well-managed execution, exceeding analyst estimates in each of its last three quarterly earnings reports. Shares of the teen-focused retailer are down nearly 26% year to date and near 52-week lows. Could it be a good time to consider buying shares?

What's driving growth at American Eagle

American Eagle Outfitters beat analyst expectations during its last three quarterly earnings releases. Strength in its Aerie brand, digital sales, and denim are some of the main drivers of the earnings beats this year. The brand continues to resonate well with teens. The retailer also has an opportunity to gain market share from competitors that are rapidly closing stores.

a group of young fashionable people taking a selfie

Image source: Getty Images.

Denim is a bright spot for the mall retailer, posting "the 25th straight quarter of record sales." The new women's Curvy collection is performing well and driving growth in the segment. American Eagle continues to add new styles to entice customers. In December, the company started selling new AirFlex jeans for men and Dream Jeans for women. American Eagle is also the largest women's jeans brand in the U.S.

Teens love the brand. American Eagle Outfitters took second place on the list of teens' favorite apparel brands in Piper Jaffray's Taking Stock with Teens survey, for the fourth time in a row. Aerie, American Eagle's lingerie brand, is also popular with teenagers. Aerie's message and advertising focuses on body positivity and inclusivity, which has resonated with Gen Z (people between ages three and 23).

Aerie continues to show strong growth. In the recent third quarter, comparable sales for Aerie increased by 20%, versus a 32% increase in the third quarter last year. Impressively, this is the 20th consecutive quarter of double-digit sales growth for the brand. Brand President Jennifer Foyle cited both new customers and increased spend as drivers for the increases. Clearly, the lingerie retailer's brand is connecting with its intended audience. Foyle commented about the brand: "[W]e advance the core tenets of empowerment and body positivity."

While American Eagle planned to open 60 total Aerie stores in 2019, L Brands' (NYSE:LB) Victoria's Secret is closing 53 stores through 2021. Twenty-four new Aerie stores opened in the third quarter. Given the ongoing store closures at Victoria's Secret, American Eagle could have room to take more market share from its competitor. Same-store sales at Victoria's Secret stores dropped 7% in the third quarter. Consumers have pointed out that the quality of Victoria's Secret garments has dropped over the last few years, and products fall apart quickly.

Risks and valuation

Even with the effective execution by American Eagle's management, the company couldn't avoid being affected by the promotional retail environment. Fourth-quarter earnings guidance was weaker than analyst estimates, and the stock traded down right after the earnings report. Management cited a challenging environment and product challenges in the top categories, pressuring gross margins in the fourth quarter. CFO Robert Madore commented on this issue: "We are taking quick action to strengthen product assortments and improve inventory management."

While near-term headwinds are likely for American Eagle shares, valuation looks appealing. Shares currently trade at 10 times forward earnings, below the 13 times for the retail industry (including apparel and shoes) and 20 times for the S&P 500. Competitors Urban Outfitters (NASDAQ:URBN) and Abercrombie and Fitch (NYSE:ANF) trade at 11 times and 14 times forward earnings, respectively. If shares traded at 13 times the consensus forward earnings of $1.47, American Eagle's stock would be valued at $19, roughly a 30% upside from its current $14.35 share price. There will likely be some choppiness for shares in the near term, but given management's successful track record and current valuation, investors who want exposure to the retail and consumer discretionary sector may want to consider taking a position, especially on any pullbacks.