After pulling up sharply over the last week, American Eagle (AEO 1.36%) got knocked down 10% today after it reported earnings per share in line with the market's expectations. As I mentioned in my preview of the company's earnings, investors seemed to have overbuilt the success that the brand would have beyond the semi-official analyst estimations. That has lots of implications, but the most important is this: The announcement wasn't indicative of a failure, just of overhype.
The apparel retailer is in the early middle stages of a brand turnaround, with 2012 being a rousing success. Earnings and comparable sales are increasing, and management has laid down a clear path to growth that's not overly risky. In short, it wants to focus on the core brand in the U.S., cut back underperforming locations, open new domestic locations, and only then think about international expansion. American Eagle still looks like a good play, and the pullback today puts its price back in line with realistic expectations for the coming year.
The fourth quarter at American Eagle
American Eagle nailed its earnings expectation, which was in line with the market's expectation. Earnings per share rose 41% to $0.55 for the quarter and $1.39 for the year. The first reason that American Eagle failed to hit the high bar set by investors this week came down to comparable sales. While it grew comps by 4% in the quarter, it saw a slowdown from its reporting in January. At that time, sales were up 5%, with the company coming off a good holiday season. On the conference call this morning, CEO Robert Hanson said that mall traffic had been lighter than anticipated, which affected comparable sales.
The second big reason the stock dropped was the company's less-than-stellar first-quarter outlook. It now expects comparable sales to fall in the first quarter. The company cited macroeconomic problems and bad weather as some of the biggest issues pushing it down. That shortfall in sales is then forecast to turn into a drop in earnings per share between 14% to 27%. Ouch.
So what is there to be excited about?
It's still not a bad time to look at American Eagle because I think management is being overly cautious. Investors have heard a lot about the economic headwinds, but most strong brands have been able to overcome those issues to keep selling. I never tire of the comparison between American Eagle and Gap (GPS 0.85%). Gap has also undergone a brand turnaround, and the company is pushing its comparable sales up despite the economy.
In its earnings statement last week, Gap said that comps rose 5% in the previous quarter and that it expects to see modest growth this year as well. I think that American Eagle has put enough into the brand over the last year that it should see similar results. While comps dropped off over the past few months, I think they'll continue to be positive through the first quarter.
That's based on the company's plan to keep trimming back underperforming stores. Over the year, American Eagle plans to shut down between 15 to 20 underperforming stores that are dragging comps down. Assuming that those closures are front-loaded, they should have less impact on the comps this coming quarter. That, along with the strength of direct sales, which increased 24% last quarter, should be enough to keep investors happy.
The bottom line
While the outlook is subdued and the earnings missed unspoken expectations, I'm not worries about American Eagle just yet. While I keep comparing it to Gap, it's helpful to take a look at other competitors such as Aeropostale (ARO +0.00%) to round the view out. Aeropostale had a fall in comps over the holidays of 8%, which was stacked on a 9% decrease from the previous year. In calls and press releases, it's become clear that management has no meaningful plan for getting out of that hole. Compared to Aeropostale, American Eagle is saint-like.
Given the context of its competition and the success that American Eagle has had over the past year, I'm happy to keep watching as things improve. I still think Gap is the better overall play, but American Eagle isn't a bad choice, and with a P/E of 18, its cost is in line with the sector average. For investors looking to invest in an apparel retailer, American Eagle offers a very good chance at growth over the next three years.
