Yesterday, we learned that American consumers are still spending somewhere, at least. Amid a flurry of downbeat second-quarter results from major retailers, American Eagle Outfitters (NYSE:AEO) reported sales up 17%, with earnings to match, a result that competitors Gap (NYSE:GPS) and Limited (NYSE:LTD) would die for.
I take comfort in these results for two reasons. First, they confirm that retail can still perform if companies have the right stuff to sell. Second, they renew my faith in the U.S. economy -- if parents can continue to plunk down money for trendy apparel for their teenagers, things can't be all that bad.
By the numbers
Comparable-store sales grew 2% during the second quarter, a marked slowdown from 2006 full-year comps of 12% and the 6% comps reported in the first quarter. But management noted that July sales were hurt by later back-to-school starting dates in some parts of the country, and Florida and Texas' decision to move tax-free buying days from July to August. No doubt these impacts were real, but AEO is also clearly feeling the effects of a generally slower retail sales trend.
Operating income grew 12% on the 17% sales climb. Gross margins were down 50 basis points, primarily on higher markdowns. SG&A expense was flat to the prior year as a percentage to sales, an impressive result on total sales that must have been lower than expected at the beginning of the year. I like to see retailers that make adjustments in midstream to control expenses.
EPS grew 19% to $0.37 a share, faster than operating income growth, thanks to a 3% lower share base. Inventories, up 17%, seem to be in reasonably good shape -- not much higher than the sales growth rate, but still 7% higher per square foot than the prior year (excluding inventory for e-commerce). Rich Smith noted on Monday that the company reported 33% inventory growth last quarter, so it's apparently making progress in clearing out early-season goods, and it seems to have adjusted purchases to bring inventories in line.
Surprising guidance
Although the company exceeded analyst EPS expectations for the second quarter by a penny, the street wasn't so upbeat over guidance for the third quarter. American Eagle is looking for earnings between $0.47 to $0.48 for the August-through-October quarter. This translates into EPS growth in the high single digits -- well below Street expectations of $0.50, which caused the stock to briefly drop yesterday on the news.
This guidance doesn't add up for me. Square footage has risen around 10%, so if comp sales are reasonably healthy, I would have expected the company to at least guide toward earnings growth in the low teens. July sales were soft because back-to-school shopping got pushed to August, which should benefit the third quarter. And the company said it was "pleased" with August sales so far.
It's hard to ignore that the stock has been in a nosedive for the last several months, along with competitors Aeropostale (NYSE:ARO), and Pacific Sunwear (NASDAQ:PSUN). But I like the current valuation of 13 times trailing-12-month earnings, which looks more than reasonable for a growth company that's been knocking the cover off the ball.
Perhaps the answer lies in playing the Wall Street expectations game. For the past four quarters, American Eagle has equaled analyst guidance twice and exceeded it twice. I'm ready to go out on a limb here and suggest the company may be guiding the Street lower, making it easier to deliver an earnings "beat" in the third quarter -- or hedging its bets if it can't. August sales will help to show whether this is the case -- or if American Eagle is continuing its descent.
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Fool contributor Timothy M. Otte surveys the retail scene from Dallas. He welcomes comments on his articles, but doesn't own shares of any companies mentioned in this article. The Fool has a disclosure policy.
