Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Why Are Investors Helping American Eagle Soar?


The company's margins prove it's in bad shape.

I've been condemning the market's overenthusiastic take on the retail sector for months. My disagreement continues as investors sent American Eagle (AEO) up over 3% yesterday on a paltry earnings report.

The new justification for buying retail stocks is that analysts claim things are "less bad." Of course this appears to be true in American Eagle's case. In comparison to last year's 7% drop in the top line, revenue slipped just 1% in comparison to last year. So the rate of sales declines is slowing.

I've beaten this point to death but I'll reiterate again: Decelerating sales declines are occurring because negative growth is compounding on top of the previous year's negative growth, not because things are starting to improve. That's precisely what's happened at American Eagle.

To illustrate just how bad of shape the company is still in, let's take a look at margins. In fiscal 2006, while the economy was peaking, AE's gross margin clocked in at an impressive 48% and its operating margin sat at 21.2%.

Today, American Eagle's gross margin has dropped a whopping 800 basis points to 41.1%. Even worse, its operating margin has eroded in half to just 9.4%.

Unfortunately, I don't see these margins getting any better. While inventory was kept in tack this quarter, management stated that it plans to increase inventory levels by a mid-single-digit percentage. Given that comps have fallen 5% already in November, I'm not sure that stocking the shelves with that much more merchandise will lead to margin expansion.

Perhaps Black Friday sales will surprise me and shoppers will flood AE stores between now and Christmas, but I'm not optimistic. To me, increased inventory translates into massive post-holiday markdowns.

In addition, management suggested that they have some "powerful promotions" in store for shoppers. Again, this will do anything but bring margins back to pre-recession levels.

Despite some of AE's aggressive markdowns throughout the downturn, I think the company's brand remains strong. I particularly like its success with Aerie (comps rose 27% for the segment). It has become Limited Brands' (LTD) biggest nightmare as it rivals Victoria Secret.

I'm also optimistic about the Martin + Osa line, which posted a 10% increase in comps. The stores feature merchandise for a more mature audience like J Crew (JCG), but at lower price points.

American Eagle is far from reaching the point of no return like Abercrombie & Fitch (ANF). However, the company has a lot of work cut out for itself in terms of getting its margins back in order and finding how to generate sales increases at its core stores.

A handful of retailers like Urban Outfitters (URBN) and True Religion (TRLG) are living proof that it isn't impossible to grow during downturns if the right merchandise is presented to shoppers. However, if American Eagle can't figure out how to do this soon, I'll be unloading my shares.
< Previous
  • 1
Next >
Position in AEO.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Featured Videos