American Eagle Outfitters (NYSE: AEO) Executive Summary and Recommendation
Investment Managers: Robert Eberhard, Jing Feng (Jeffrey) Li, Rob Jannusch
March 13, 2014
Company Overview
American Eagle Outfitters (AEO) is a retailer that designs, markets, and sells apparelprimarilyin the United States and Canada, as well as online at ae.com. Founded in 1977 and headquartered in Pittsburgh, Pennsylvania, the company functions in three key market segments – American Eagle, aerie by American Eagle, andAEO Direct. Through the Company’s family of brands, it offers clothing, accessories, footwear, intimates and personal care products. As ofFebruary 1, 2014, the Company operated 1,066stores in the United States, Canada and Puerto Rico under the American Eagle Outfittersandaeriebrands as well as 66 international stores. AEO Direct, its e-commerce operation subsidiary, ships tomore than 80 countries worldwide. During Fiscal 2013, the company opened 64 new stores, including 39 AEO Factory stores, and closed 42 under-performing stores. This was within the guidance provided by the company last year and the company is projecting slower growth in the year ahead.
Macroeconomic and Industry Overview
In 2013, home values and equity prices rose, gas prices fell, and there was stagnant wage growth for consumers even as unemployment fell in the U.S. Even so, the S&P Retail Index grew 40% in 2013, outperforming the broader S&P 500. Within the retail industry, which is driven by consumer discretionary income, retailers with operations nimble enough to capitalize on trends such as growth in direct-to-consumer/factory stores and speed-to-market capabilities are best positioned within an industry that is poised for growth in 2014. According to the National Retail Federation, retail sales are expected to rise 7.8% in 2014, with online sales expected to grow between 9-12%.
Financial Analysis, Projections, and Valuation
Between 2013 and 2014, American Eagle is planning on spending over $500 million dollars as it attempts to improve the speed with which it gets its products to customers. Half these expenditures will focus on upgrading systems and the completion of a new distribution center, while the rest will be used to upgrade stores, expand internationally, and develop more factory stores in the United States.
These capital expenditures will impact the company’s free cash flow in the short-term, but once these large projects are completed, there is no reason why the company cannot return to its previous operations. Considering this impact on free cash flow, the discounted cash flow valuation generates a value of $15.59 a share. Because American Eagle works in a highly competitive industry, we also compared American Eagle to five of its closest competitors, which implied a valuation of $15.18 a share.
Recommendation
The RCMP investment management team recommends a HOLD for American Eagle. The company is competing well with its main competitors in the retail space, has no debt and is investing for the future by expending capital now. After taking a hit because of earnings on March 11, the stock now trades below our weighted valuation of $15.34, and we think that it can return to this price within the 18-24 months.