Wednesday, August 27, 2008

Screen Result No. 2: American Eagle Outfitters

The second stock that met the criteria of my screen is a company I feel strongly about. I recently did a little intelligence gathering at one of its stores, and I've been immersed in their financials ever since. So I was happy when I saw I would have the opportunity to write about American Eagle Outfitters in this series.

Yesterday I wrote about Best Buy, a store I really like. I can't say that I particularly like American Eagle Outfitters' clothes. I've generally considered them Abercrombie Lite, though that's changing. I've been inside American Eagle stores a few times, though I've never seen anything I particularly wanted to buy. But, alas, I'm not 18 anymore. I'm pretty far removed from American Eagle's target demographic.

I do, however, like Martin + Osa. This is American Eagle's new concept, which target people my age (and, frankly, "size." Did I mention I'm not 18 anymore?). Their clothes are well-made, stylish without being disturbingly metrosexual, and everything is the store is nice to touch, which bodes well for comfort. M+O doesn't sell anything except casual clothes, and I think they hit the mark. Their stores make me feel at home, relaxed; I'm not intimated by the clothes, incredulous at the prices or leery of the help. Think of them as the anti-Banana. That combination of factors gets me into the dressing room. And the dressing rooms are really something to behold. If you haven't been to a Martin + Osa store, go. And take your American Express card.

I think Martin + Osa will do a lot to drive AEO's earnings. I feel the same way about aerie. Let me be clear: I have not ventured into this young women's unmentionables store, and I do not plan to unless my daughter asks me to take her. But the mood is reportedly the same: aerie is designed to be comfortable and accessible. If Mortin + Osa is the anti-Banana, then aerie is the anti-Victoria's Secret. I think this atmosphere is bound to resonate with consumers.

All in all, American Eagle has done an outstanding job offering products for each demographic segment. It targets kids, young adults and the over-25 set. Gap's offerings have no linkage. You never graduate. Gap's smattering of concepts merely attempt to appeal to different price points. AEO is much more strategic. They've created a more refined approach -- and I think that shows in its performance. (Chico's has pulled off the same trick with its Soma and White House Black Market stores.).

Lately, though, the stock has had a rough go. AEO is down -32% for the year, about twice the drubbing the S&P has taken. AEO is trading at a mere nine times earnings. Is this a good value?

Let's consider the questions we're asking of each company that meets this week's screen.

How have earnings per share fared over time?
Earnings per share have grown an average +30.8% for the past six years, and the first few years of that was pretty choppy. On the whole, though, earnings growth has grown faster than revenue growth, which is a good sign.

Is that likely to continue?
Given the growing concepts, new American Eagle stores and an extensive remodeling campaign, I think that growth trend is indeed likely to continue. Each new store adds $2.5 million in sales. Data from the company suggest that remodeling increases sales +33%, earnings +43% in profits and +40% in store space.

Where does that put per-share results in two years?
Thirty-percent growth takes EPS to $3.08 in two years.

What do analysts forecast?
Analysts see a decline in earnings, from $1.82 to $1.52, according to Bloomberg. This is a drop of -16.5%, a little larger than AEO's last earnings slip, a -14.6% slide in 2003.

What is the current earnings multiple?
Nine.

How close is it to the stock's historical average?
It's significantly lower than the average 14 for the past three years. Where will the multiple be in two years? I think the multiple will return to its average when the economy regains its footing. Investors are frightened that consumers are tapped out.

Given these earnings estimates and PE predictions, what will the fair market value of the stock be in two years?
I see a PE of 14 and EPS of $2.90 to $3.00. That gives the shares a fair value of $42 and implies 200% in upside.

Am I willing to accept the risk/reward this investment represents?
I think these shares are being terribly underestimated. I think the remodeling, store openings and new concepts will drive earnings far more than Wall Street is betting. Do I understand the business? I don't know fashion, but I know that American Eagle and Martin + Osa looked better than I have ever seen at the shareholders meeting. American Eagle has come into its own and no longer looks like an Abercrombie knock-off. It also has a strong denim business, and denim is still hot. And aerie is going great guns -- forgive me, I had to say it -- in its attempts to sell comfortable bras, underwear and "dormwear" to young women who want something comfier than Victoria's Secret silky elegance.

Do I want to be an owner of the company? Can I articulate why?
I want to own these shares to capitalize on management's continued success and to profit when the market realizes that AEO is going to maintain its strong history of results. I honestly think that analysts' kids shop at Abercrombie and that that has an effect on Wall Street's perceptions. Bottom line: Revenue will exceed expectations, and the company, which operates at a net margin of 10%, will surprise with strong earnings than expected. Management has achieved nearly a 30% return on equity -- impressive considering the company has no long-term debt -- and is expected to do even better.

If nothing else, you can probably talk your way into a little discount at Martin + Osa by telling them you're a shareholder. What the hell. It works at Nebraska Furniture Mart…

1 comment:

Ashly said...

Interesting post..! I think American Eagle Outfitters is the best store for shopping.