The apparel industry is always subject to fast paced changing consumer preferences, fashion trends, and non-existent switching costs. Therefore, it’s difficult for brands like Abercrombie & Fitch (NYSE:ANF), Urban Outfitters Inc. (NASDAQ:URBN) or Aeropostale (NYSE:ARO) to sustain same level growth and sales margins. American Eagle Outfitters (NYSE:AEO) has been a popular global specialty retailer since 1977, and currently operates over 1,000 stores in North America and 61 franchised shops, distributed amongst 12 countries. However, this holiday season showed weak same store sales, causing some investment gurus like John Hussman (Trades, Portfolio) to sell out their company shares. So, let’s take a look at what’s happening with this retailer’s business model.
A Tricky Scenario
Now, American Eagle Outfitters has been a popular brand amongst teenagers for over three decades, and its market cap of $2.7 billion is larger than other brands like Abercrombie & Fitch and Aeropostale. However, the stiff market competition and low barriers to entry have recently put additional pressure on this retailer. The firm sells a large variety of quality clothing, accessories, and personal care products at accessible prices, for a young target of 16-24 year olds. Apart from the 932 brand stores, mainly in the U.S., the company also owns a second brand, Aerie, which sells intimates and underwear for females in 132 stores. Additionally, both brand products can be bought through the online portal ae.com and aerie.com, and shipped to 81 countries around the globe.
Despite the quality and low price of its products, and constant promotional offerings, this specialty retailer is exposed to a complicated scenario, where fickle teenage consumer habits, along with no switching costs, creates a deadly combination. In addition to this, the American Eagle Brand offers denim, shirts and hoodies, an assembly of clothes which can easily be purchased for the same or lower price, at competitors like H&M, Forever 21 or Urban Outfitters. Therefore, volatile same-store sales should come as no surprise: while 2012 showed a positive 9% bump, the end of fiscal 2013 (most affected by the holiday season) crashed this metric to a negative 5%. The 16.2% unemployment rate amongst the target ages 16 to 24 (double the general rate) is also a strong damper when it comes to consumer spending.
The Pressure Is On
The American Eagle management team is focused on turning last year’s dim results around. How? Well, the main strategy will consist of offering more merchandise assortments, adding more compelling brands, managing inventory levels and enhancing the online business segment. In order to revive sales and profitability, the strategic store expansion plan will close underperforming units and focus resources on international territory. This could be a key growth factor for the company’s future, since emerging markets and China are vastly untapped by the brand. The profits earned from online sales are up 17% year over year, which could be an indicator of the company’s popularity outside the U.S.
Although uncertainty remains regarding the firms future profitability, due to the 8 point drop in operating profits since 2008 (currently at 11.4%) and sluggish revenue growth of 7.30%, this retailer has strong enough fundamentals to overcome this rough patch. With virtually no debt, an above average dividend yield of 2.80% and a return on capital of 68%, I feel bullish that American Eagle Outfitters will pick up its pace in 2014 and 2015. And despite a current stalled EBITDA growth of 12.70%, the company shares trading at a price discount of 14% compared to the industry’s average could benefit investors looking for long-term growth opportunities.
Disclosure: Damian Illia holds no position in any stocks mentioned.