Retail Headwinds Could Engulf American Eagle – American Eagle Outfitters, Inc. (NYSE:AEO)

Source: Barron’s

American Eagle Outfitters (AEO) reports quarterly earnings March 4th. Analysts expect revenue of $1.27 billion and EPS of $0.36. The revenue estimate implies flat growth Y/Y. Investors should focus on the following key items.

Will Revenue Growth Finally Slow?

Several retailers have faced headwinds to their top lines. Several have had to engage in heavy promotions in order to drive traffic to stores. Discounting may have buttressed the top line, yet crimped margins. Companies with nascent digital platforms have found it particularly difficult to survive the retail wars. American Eagle, Kohl’s (KSS) and Abercrombie & Fitch (ANF) were hit hard by the heavy promotional environment last quarter.

Last quarter, American Eagle reported revenue of $1.1 billion, up 6% Y/Y. This was a solid performance given revenue declines experienced by competitors. Total comparable sales rose 5%, driven by the number of transactions, partially offset by a lower average transaction size. Average unit retail price was also lower, implying the company had to work harder to generate revenue. Comparable sales for American Eagle and Aerie rose 2% and 20%, respectively. Digital sales rose by double-digits and represented about 28% of total revenue; this was important, as more retail sales shifted to online.

American Eagle has been one of the few success stories in retail on the strength of its Aerie brand. Aerie has helped differentiate the company. The brand celebrates women of all sizes. Its strong promotion of body positively and empowerment has resonated and led to out-sized sales growth. Aerie’s success may have come at the expense of Victoria’s Secret. L Brands (LB) recently parted with the struggling brand at a fire sale price. Aerie’s sales growth should remain strong, but will it be able to offset weakness at other parts of American Eagle?

Margins Tumbled

American Eagle’s gross margin tumbled 160 basis points to 38.2%. This was a sea change compared to the gross margin increase in the prior quarter. On a dollar basis, gross profit of $407 million rose 2% Y/Y. Gross profit rose less than revenue due to margin erosion. Again, several retailers had to discount prices to drive traffic. Customers flocked to Target (TGT) Lululemon (LULU) and certain off-price retailers sans promotions. Many retailers were not so lucky.

Pursuant to American Eagle, the back-to-school season experienced softer demand in certain apparel categories. Gross margin was negatively impacted by higher warehousing costs and higher markdowns within the American Eagle brand. The American Eagle brand represented over 75% of the company’s total revenue, so the promotional activity likely had an out-sized impact on financial results. Cowen analyst Oliver Chen recently warned American Eagle’s traffic issues could persist. This could imply even lower gross margins this quarter.

SG&A expense was $259 million, up 4% Y/Y. Selling costs and professional fees rose, slightly offset by lower incentive compensation. SG&A as a percentage of revenue was 24.3%, down 50 basis points versus the year-earlier period. The fact that growth in SG&A costs outstripped growth in gross margin caused EBITDA to decline. EBITDA of $148 million fell 2% Y/Y. EBITDA margin was 13.9%, down 110 basis points versus the year-earlier period. Management must cut into SG&A costs or EBITDA will likely continue to decline. Cutting SG&A could prove difficult given the need to invest in the digital channel to keep pace with Amazon (AMZN), Target and Macy’s (M).

Strong Liquidity

American Eagle has $265 million in cash and short-term investments. Its working capital exceeds $260 million and it has no debt to speak of. The company’s strong liquidity could help it survive the retail wars. It could also separate American Eagle from J. C. Penney (JCP) and Bed Bath & Beyond (BBBY) who either have paltry liquidity or are reeling from declines in EBITDA. Through the first 39 weeks of the year, American Eagle’s cash flow from operations was $178 million. Positive cash flow could ensure the company’s liquidity grows. The retail wars could be decided by who has the best balance sheet. American Eagle appears to be well-positioned relative to some of its peers.


AEO is down over 35% Y/Y. Its decline came amid an incessant melt-up in financial markets. Sans more Fed stimulus, the financial markets could falter and cause more declines at AEO. Sell the stock.

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