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American Eagle Beats Earnings Expectations, But Not Shareholders'

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Management overlooks the problems the company currently faces.

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I'd be lying if I said I wasn't thrilled that American Eagle's (AEO) recent rebound in price has excited me. I'm a shareholder who purchased nearly two years ago, so it feels good to finally see some recovery in my portfolio. Unfortunately, though, I'd also be lying if I told you I liked what I saw when I opened up the company's second-quarter results. While the retailer met analyst earnings expectations, it didn't meet my own.

It was no surprise that sales fell 5% -- and comps fell 10% -- as AE's monthly sales figures have been far from positive. I knew that was coming. What bothered me was management's tendency to overlook the problems the company is currently faced with. Three specific quotes in the press release came across as if CEO Jim O'Donnell thought he was communicating to a group of analysts who didn't have the financials in front of them.

His statement that "AE is making clear progress on key AE brand initiatives" is dubious. Like every other retailer under the sun, American Eagle is playing the markdown game and running huge promotions to get inventory off the shelves. It's curtailing falling sales now at the expense of its long-term brand image. In addition, it's slowing shrinking their gross margin – the damage this quarter was 190 basis points. In the retail world, huge discounts equals brand erosion.

Secondly, his comment that "we continue a relentless focus on strengthening our organization with talent and streamlined processes, as well as our connection to customers" is suspect. Word on the street -- and I should emphasize the phrase "word on the street" -- is that the company (whose headquarters happen to be my hometown of Pittsburgh), is issuing lay-offs. I'm puzzled how Mr. O'Donnel thinks he's "strengthening talent" by showing the talent the door.

Lastly, AE claimed that "operational efficiency and financial discipline" governed the business." Really? Because on the financials, I read, SG&A expenses rose 230 basis points and the operating margin fell nearly in half. That doesn't exactly scream operational efficiency.

It pains me to write this article because not only am I a shareholder, I do genuinely like the American Eagle brand. I've always liked the company's operational strategies and have been impressed with their inventory management system. And as a young professional, I still wear their clothing and think they produce a reasonable product.

I certainly don't think American Eagle is a doomed retailer like some of its peers -- Pacific Sunwear (PSUN) and Abercrombie & Fitch (ANF) to name a few -- as I'm still a shareholder and think that in the past, AE has displayed characteristics of a strong retail entity. I also think AE carries a powerful brand name -- management hasn't completely eroded the brand with its markdowns.

However, the company has made some poor decisions throughout the recession and management definitely needs to get its act together if it wants to maintain the company's status as a leading teen retailer.
Position in AEO.
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