American Eagle Outfitters (NYSE: AEO)
Investment Managers: Ming Lee, Yen-Ju (Annie) Lin, Jiaqi (Tommy) Jiang, Lu Han, Yanan (Phoebe) Tan
Position: 1000 shares at an adjusted cost basis of $5.22/share after multiple purchases, splits and sales.
Oct. 27, 2015
Company Overview
American Eagle Outfitters, Inc. is a leading apparel and accessories retailer. It was founded in 1977 in Delaware. As of January 31, 2015, it has 1,056 retail stores, with 920 stores in the U.S., 101 in Canada, 18 in Mexico, 9 in China, 6 in Puerto Rico, 5 in Hong Kong and 3 in the United Kingdom. The Company’s online business, AEO Direct, ships to 81 countries worldwide. The company has two brands, American Eagle Outfitters ® and aerie ®. The American Eagle Outfitters ® brand targets 15 to 25 year olds men and women. The aerie ® brand is a collection of intimates and personal care products.
Macroeconomic and Industry Overview
The disposable income growth rate is overall stable except United States debt-ceiling crisis of 2013 and 2008 financial crisis. The recent ten-year effective annual growth rate of disposable income is 3.7%. Cotton price remains at a low level, but the cotton price has very small effect on cost of sales for the industry because most companies sign long-term fixed price contract with clothing manufactures in Asia. The clothing and clothing accessories industry is highly seasonal cyclical. Inventories pile up during the year and drop when the sales peaks at holiday seasons in December. After adjustment for seasonal factor, the inventory/sales level maintains at a low level after 2008, due to efficient management of inventory to avoid inventory obsolete. Annual sales growth for the whole industry in recent 10 years is around 2.55%. Lastly, the industry’s e-commerce sales stable at 17.5%, total commerce sales growth gradually falls from 17% to 14.9% from 2013 to 2015* and is expected to fall slowly in next three years.
Financial Analysis, Projection, and Valuation
AEO’s ROA and ROE decreased significantly due to a drop in sales during the last two years even though they have improved its business strategy and focused more on online-sales by closing existing stores every year. The comparable analysis implies a value of $12.98 and $14.24 under discounted free cash flow analysis.
Recommendation
We recommend a sell for American Eagle Outfitters. Even though the company used to have outstanding earnings among apparel industry and continue to improve its business strategy, they still fail to create enough value for investors under fierce competitions. We expect lower earnings in the following years will eventually bring down the stock price below current level.