Is the Sell-Off in American Eagle Outfitter’s Stock an Opportunity?

source: http://www.flickr.com/photos/cc_chapman/

source: http://www.flickr.com/photos/cc_chapman/

American Eagle Outfitters, Inc. (NYSE:AEO) is a leading global specialty retailer offering high-quality, on-trend clothing, accessories, and personal care products at affordable prices under its American Eagle Outfitters and Aerie brands. The company operates more than 1,000 stores in the United States, Canada, Mexico, China, and Hong Kong, and ships to eighty-one countries worldwide through its websites.

American Eagle Outfitters and Aerie merchandise also is available at seventy-seven licensed international franchise stores in thirteen countries. The stock is being crushed today after reporting mixed results from its first quarter. Shares currently trade at a new fifty-two week low of $10.60, bringing the yield to 4.5 percent on this stock. If the dividend can be maintained, the stock is attractive to initiate a position at these levels. An analysis of the company’s earnings can help inform this possibility.

American Eagle reported earnings of $0.02 per diluted share for the first quarter ended May 3, 2014, compared to adjusted earnings of $0.18 per diluted share for the comparable quarter last year. That is painful. Total net revenue decreased 5 percent to $646 million from $679 million last year. Total revenue included growth from non-comp factory stores, international stores and licensed store revenue. Consolidated comparable sales decreased 10 percent, following a 5 percent decrease last year. Gross profit decreased 15 percent to $226 million and 420 basis points to 34.9 percent as a rate to revenue.

 

Gross margin reflected the de-leverage of rent on negative comparable sales and increased markdowns, partially offset by favorability in merchandise and design costs. Selling, general, and administrative expenses of $185 million increased 2 percent or $4.3 million, which included $2.3 million in severance. Investments in factory stores, international and omni-channel drove the increase, and were largely offset by $10 million of expense reductions. Operating income decreased 85 percent to $8 million. The operating margin decreased 710 basis points to 1.3 percent. Earnings of $0.02 compares to adjusted earnings of $0.18 last year.

Total merchandise inventories at the end of the first quarter declined 3 percent to $329 million compared to $341 million last year. At cost per foot, inventory decreased 7 percent. Inventories reflect a change to ownership terms completed late last year, as we began taking ownership of inventory at the receiving port rather than the port of departure. Excluding the change in terms, inventory at cost per foot increased in the mid single-digits. Second quarter 2014 ending inventory at cost per foot is expected to decline in the mid teens, or mid single-digits excluding the change in ownership terms. In the first quarter, capital expenditures totaled $72 million.

For fiscal 2014, the company continues to expect capital expenditures of approximately $230 million. The company opened eleven new stores, including five factory stores, two stores in Mexico, and one store in China, and closed twenty locations, including fourteen Aerie stores. Three new North American mainline stores opened in key markets. Additionally, the company added eleven international licensed stores, including its first store in Colombia, and ended the quarter with seventy-seven licensed stores in thirteen countries.

Jay Schottenstein, Interim CEO, stated: “Results were consistent with our expectations. The quarter reflected weak sales and increased markdowns. We are committed to improved profitability and are working hard to implement our plan to strengthen our brands, channels and operations. Specific actions underway include continuing to build strong omni-channel capabilities, rationalizing our store fleet, reducing expenses, growing international licensed stores, and most importantly, delivering great merchandise and customer experience across our brands. Our focus is on leveraging our strong brands and talented team in order to deliver long-term profitable growth and enhanced value for our shareholders.”

Looking ahead, based on a high single-digit decline in comparable sales, management expects second quarter earnings to be approximately break-even compared to earnings of $0.10 per diluted share last year. The guidance excludes potential asset impairment and restructuring charges. Following a comprehensive fleet review, the company has identified an additional 150 stores to close in North America over the next three years, including nearly 100 American Eagle stores. For 2014, the company is planning to close approximately 50 American Eagle and twenty Aerie stores in North America. Beginning in 2015, the company anticipates annualized after-tax savings of approximately $10-$15 million related to these store closures.

All things considered, I don’t think the dividend is safe. The company simply is not delivering the results they should be. Management claims results were in line with expectations. As an investor, I would encourage management to raise the bar. Despite what appears to be an attractive entry point for this once lucrative stock, until the company shows signs of improvements, I cannot recommend it.

Christopher F. Davis hold no position in American Eagle. He has no intentions of initiating a position in the 72 hours. He has a sell rating on the stock and a $8.75 price target.

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