The slowdown resulting from the trade war has had a far-reaching impact across a number of sectors, and one of the affected is retail. While U.S. consumption has not started slowing down yet, it is a matter of time before discretionary consumer spending starts dropping. One of the slowest performing sub-sectors within retail this year has been the apparel retail market, where stocks are already trading at low multiples owing to the reduced market optimism. One such stock which has recently delivered decent results in these tough times is American Eagle Outfitters (AEO, Financial).
Strong performance in Aerie and Denims
American Eagle is a Pittsburgh-based specialty retailer focused on the apparel and accessories markets for men and women. It has stores under the brand names of American Eagle, Aerie, Tailgate and Todd Snyder. While its store presence is strong in the U.S., Canada, UK, China and Hong Kong, it ships its products across the globe and is a very well-known global apparel brand.
Since American Eagle operates within the apparel retail space, which hasn’t been one of the best performers in the past year, the analyst expectations with respect to the company’s results have been low, giving it the chance to outperform. For the most recent quarter, the management reported a top-line of $1.07 billion, above the analyst consensus figure of $1.06 billion. The company did well on same-store sales; for the second quarter in a row, Denims continue to be one of the biggest drivers of the company’s revenues. The management recently launched its curvy line of denims designed for a better fit for people with larger hips, which seems to be gaining excellent traction.
Another reason why American Eagle has outperformed on the revenue front is the excellent performance of its Aerie stores. The management has attempted to create a very strong brand differentiation through Aerie by countering body shaming and catering to consumers of all sizes. This has appealed well to consumers, and the comparable sales for these stores have witnessed double-digit growth.
American Eagle’s digital strategy has shown success as well, and its online sales have been gradually rising over each passing quarter. Today, these digital sales account for about 28% of the total top-line and almost half of these come from the company’s mobile app and other channels.
Why margin expectations are low
Margins have always been a point of concern for American Eagle and it managed to live up to the analyst estimate of 48 cents per share for the most recent quarter, the same level as that in the corresponding quarter of the previous year. However, there are big changes in the cost structure as the gross margin has gone down by around 160 basis points, largely impacted by the merchandising unit. The management’s efforts at managing indirect costs has helped in pushing up the net margin and the overall earnings per share to the same level as the previous year. Also, its inventory levels are gradually rising (about 9% higher in the most recent quarter) and the general outlook provided by the management with respect to the same-store sales is more or less flat as they are not expecting anything phenomenal from the upcoming season sales. This is not encouraging news for investors and is another reason why the stock is cheap.
Abercrombie & Fitch (ANF, Financial) can be considered the closest competitor to American Eagle inÂ terms of products and target consumers, and these two companies are engaged in a tough price war right now, which has impacted both their businesses.
The above infographic looks to compare 3 fundamental levers of both apparel retail giants, i.e. the revenue growth, the margins and the valuation. American Eagle clearly has the edge on all counts with a superior operating margin, better top-line growth and a lower price-to-earnings valuation. However, the stock price performance narrates a completely different story altogether.
While 2019 may have been a rough year for both these companies, from a long-term perspective, Abercrombie & Fitch has been a much better performer. The company saw its stock price appreciate by 29% in the past three years despite the recent slowdown, whereas American Eagle has seen a value depreciation of 10% in this period. Where is the problem? It lies in investor perception as the market is clearly perceiving better future value in Abercrombie & Fitch as compared to American Eagle. This is the reason why the former also has much higher valuation multiples and why American Eagle, as a stock, is so cheaply priced.
There is little doubt that American Eagle is undervalued today. The price is currently below the Peter Lynch fair value and hardly 0.94 times the Graham number. There have been some gurus buying the stock in the quarter ending September 2019, includingÂ Mario Gabelli (Trades, Portfolio), who made it a new addition to its portfolio. However, given the apparel retail slowdown and the weak market perception, investors of American Eagle would probably have to wait for a while before the market sees a good future value and starts pricing the stock at a decent premium.
Disclosure: No positions.
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