About a year ago, I wrote a story on the 50% dividend increase at American Eagle Outfitters
Those few souls out there who purchased shares in late 2003 and have held on are now receiving a 3.3% yield on their purchase price. With today's 50% increase in the dividend, those who purchased and managed to hold on are now earning a 5% yield on their purchase price. For those purchasing today, the yield will now come in at 1.4%. That's not bad, considering that the overall valuation on American Eagle is reasonable, but those who purchased at $20 to $25 on the decline a few months back are already looking at a 2% yield on their purchase price.
Given that the company has increased its dividend 50% in each of the last two years, it makes sense to take a look and see whether the current dividend is sustainable. With some adjustments to operating cash flow, I estimate that American Eagle generated $418 million in free cash flow over the trailing 12 months. Over the same period, the dividend came in at $45.6 million. Factoring in a 50% increase brings next year's total dividend pay out to approximately $68.4 million, or 16% of my free cash flow estimate. Given this level of dividend coverage, the dividend looks very secure even if you assume margin declines that are likely to materialize in a recession.
However, I'd argue that additional dividend increases are likely in future years, because of the company's strong balance sheet and its planned launch of Martin + Osa in the fall. The new shops will undoubtedly take a few years to get up to speed, but they will give American Eagle another avenue for growth with the ability to appeal to shoppers currently turning toward Gap
It is possible, of course, that American Eagle could tread water or struggle for a few years in a recession. But the combination of healthy financials, potential for growth from Martin + Osa, and a valuation that has only low-single-digit growth priced in has me fairly excited about what shares of American Eagle Outfitters might do over the next three to five years.