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How Can American Eagle Outfitters Improve Profitability?

By Jennifer Saibil - Mar 18, 2020 at 8:20AM

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The popular teen apparel company had record revenue in its fourth quarter, but profits didn’t keep up.

While on the surface a company that's posting record revenue seems like it must be doing well, it's always wise to dig deeper and see how management is actually accomplishing that feat.

In the case of American Eagle Outfitters (AEO 2.24%), the 2019 fourth quarter improved 6% year over year to $1.31 billion. That's a significant increase, especially considering the so-called demise of retail apparel shops and malls. 

However, profitability deteriorated, with earnings per share coming in at $0.03 versus $0.43 for the same time last year, a whopping decrease. Gross profit declined 5% and gross margin was 31% versus 34.6% last year.

Teenagers at the movies.

Image source: American Eagle Outfitters.

A desperate holiday season?

American Eagle Outfitters had its fifth consecutive year of positive comps, so the company is certainly still a strong contender in retail. However, most of the good stuff is coming from the Aerie line, which was up 26% for the quarter, an even higher increase than last year's 23%. This is a brand that has momentum. 

American Eagle brand, on the other hand, saw a 3% decrease in comps, and to get there, the brands had high promotional activity over the holiday season. Despite this, it's still a hugely popular retailer, with the No. 2 spot right behind Nike for its target market, and it has cash in the bank, so some serious turnaround efforts should bear fruit quickly. Well, that and the end of the financial fallout from the coronavirus pandemic.

There are two roads to creating profitability -- scoring higher sales or cutting expenses. So let's look at this from both perspectives.

Creating a community

In terms of increasing sales, American Eagle's best option is to fuel more full-price sales. One way to do that is to continue developing a community, a plan that the company has not fully capitalized on. According to a Piper Jaffray survey, American Eagle tops Urban Outfitters as favorite teenage brand and just edged out the rival brand Urban Outfitters for the favorite web site No. 3 spot, after Amazon and Nike, for Fall 2019. 

It's a huge opportunity for the niche retailer since 45% of revenue comes from digital and growth is in the double-digits. With a more enhanced omnichannel experience, American Eagle can leverage synergies to its benefit. Company connection creates loyalty, and this spurs full-price sales. So while digital is hot, the company needs to strike to full effect.

Another way to drive full-price sales is to better allocate the product mix. CEO Jay Schottenstein said that the main source of promotional activity over the holidays was in women's and men's tops. The company is working on tweaking those categories, but also trying to meet the demand for bottoms, particularly jeans, which performed well. The company is expecting women's tops to do better in the first quarter of 2020, but not necessarily to turn positive until later on this year. 

Cutting costs

Cutting costs is less of an issue for American Eagle than strengthening its product segments, and a large portion of what cut away the fourth-quarter earnings was impairment and restructuring charges for 20 unprofitable stores. That's more of a signal of the retail atmosphere in general, and the company's dealing swiftly with them puts it in a better position to profit from its fleet in the coming year. The company's plan is to boost spending this year to improve the product mix and thereby the bottom line, but it will take time. 

Meanwhile, American Eagle ended the year with $417 million in cash and no debt, a healthy cash position from which to operate in 2020 and help it weather the inevitable negative effects of the coronavirus outbreak on its business and its stock price.

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