Financial Analysis of American Eagle Outfitters : American Eagle Outfitters (NYSE: AEO) is an American clothing and accessories retailer based in Pittsburgh, Pennsylvania. American Eagle Outfitters, Inc., through its subsidiaries, ("AEO, Inc.")offers high-quality, on-trend clothing, accessories and personal care products at affordable prices. The American Eagle Outfitters brand targets 15 to 25 year old girls and guys, with 900+ stores in the U.S. and Canada and online at www.ae.com. aerie by American Eagle offers apparel and intimates collections for the AE girl, with 150+ stand-alone stores in the U.S. and Canada and online at www.aerie.com. The latest brand, 77kids by American Eagle, is available online at www.77kids.com, as well as at nine stores across the nation. The 77kids brand offers small sizes and great big style for kids 0-14. AE.COM, the online home of the brands of AEO, Inc. ships to 76 countries worldwide.[3]
It was founded in 1977 by Mark and Jerry Silverman as a subsidiary of Retail Ventures, Inc., a company which also owned and operated Silverman's Menswear. The Silvermans sold their ownership interests in 1991.[4] On March 16, 2010, American Eagle Outfitters opened its first store in the Middle East at Mirdif City Centre in Dubai, United Arab Emirates.[5] Some of the best selling products of American Eagle Outfitters are low-rise jeans, polo shirts, graphic T-shirts (with the AE logo and year established), henleys, boxers and briefs, outerwear, and swimwear.

American Eagle (NYSE: AEO) is a mall-based apparel and accessories retailer that sells its own brands of products throughout the U.S. and Canada. AEO operates three different chains (American Eagle Outfitters, aerie, and Martin + OSA), each of which targets a different segment of customers within the broad 15-40 age group.[1] While AEO maintains three separate brands, the overwhelming majority of AEO's sales come from its namesake American Eagle operations. In fiscal 2009, AEO generated $2.99 billion[1] of sales with a 8% operating margin[2], placing it second in the youth apparel retail sub-market in terms of operating profit and revenue behind high-end competitor Abercrombie & Fitch Company (ANF).

AEO has branched out from its 15 to 27 year old customer segment in order to diversify and enhance its scope and scale. During 2006, AEO launched its sub-brands aerie (lingerie) and Martin + OSA (sportswear) to target a broader customer base.[3] In order to enter new markets, AEO has also entered into a partnership with an international retail operator to open stores in the Middle East. This decision has the added benefit of reducing the effects of U.S. economic cycles on AEO's bottom line. The recession in the American economy led to decreased sales in two of AEO's most important seasons: back to school and holiday.

On March 10, 2010, AEO announced that it would be discontinuing operations in its Martin + OSA stores. Once heralded as the next step in growth for AEO, M+O had not been achieving sales up to par with expectations since its inception in 2006. This discontinuation comes at a time when other fashion retail companies like A&F have been trying to expand their target age demographic without much success.

Contents
1 Looking for a place to start contributing?
2 Business Overview
3 Business Financials
3.1 FY 2009 Performance
3.2 Q1 Fiscal 2010 (ended May 1st, 2010)
3.3 Q2 Fiscal 2010 (ended July 31st, 2010)
3.4 Q3 Fiscal 2010 (ended October 31, 2010)
3.5 Business Segments
4 Trends and Forces
4.1 AEO is Limited in Their Ability to Anticipate and Respond to Changing Consumer Preferences and Fashion Trends
4.2 American Eagle's Main Sales Seasons Impacted by Recession
4.3 American Eagle Beginning to Expand Internationally
4.4 Increases in Commodity Prices Will Raise Clothing Retailer Prices
5 Competition
6 References
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Business Overview



An American Eagle Outfitters storefront in a mall
American Eagle sells its own brands of clothing and accessories in mall-based retail stores in the U.S. and Canada.

Once the lynchpins of AEO's growth plans, aerie and Martin + OSA's performance have come under scrutiny in the past year. aerie offers intimate apparel (underwear, bras, pajamas, robes, etc.) to 15 to 25 year old women, whereas Martin + OSA sells denim and sportswear designed for 25 to 40 year old men and women. Though Martin + OSA has shown improvement since the last fiscal year, making over $40 million in net income, AEO completed closure of Martin + OSA during the second quarter of 2010.[4]

Business Financials

FY 2009 Performance
2009 saw a continued decrease in revenue, same store sales and operating margin, though at a lower pace than in 2008. AEO posted sales of $2.9 B and an operating margin of 8%. [1] Same store sales fell 4% while operating margins fell to 8% from 10.1% in 2008. While the 2009 financial figures may show a continued dip, AEO's strong Q4 earnings show indications of recovery down the road as the retail climate as well as the economy picks up. One notable trend has been the decrease in operating margin that AEO has seen. AEO has seen a decreasing operating margin since FY 2008, indicating that AEO may be making its sales due to lower prices, a trend that AEO hopes to reverse in the later year.

Q1 Fiscal 2010 (ended May 1st, 2010)
American Eagle reported net sales of $659.5 million, a 7.8% increase compared to Q1 fiscal 2009.[5]
Despite stronger sales figures, the firm reported a decrease in operating income by over 50%, from $27.3 million in Q2 fiscal 2009 to $13.1 million due to increased Selling, General & Administrative Expenses (SG&A).[5]
AEO reported net income of $10.9 million, compared to net income of $22.0 million in Q2 fiscal 2009.[5]

Q2 Fiscal 2010 (ended July 31st, 2010)
American Eagle reported net sales of $652 million, a 1% increase from Q2 fiscal 2010.[6]
AEO reported a comparable store sales decrease of 1% for the period.[6]
Despite flattish sales results, AEO reported a 6% increase in gross profit to $240 million.[6]
The gross profit increase translated into a 1.5% increase in net income, to $9.66 million.[6]
For Q3 fiscal 2010, American Eagle expects comp. store sales to be flat, and Earnings Per Diluted Share (EPADS) to be in the range of $0.23 to $0.26.[6]
Q3 Fiscal 2010 (ended October 31, 2010)
Total sales for third quarter increased 2% to $752 million, compared to third quarter sales of 2009. Comparable store sales increased 1% compared to a 4% decrease for the same period last year.[7]
Gross profit increased 3% to $312 million. Third quarter operating margin was 12.2%, compared to 11.5% of last year.
Operating income increased 7.1% to $91 million.[8]
October sales decreased 1% to $188 million compared to the same period from a year ago. Comparable store sales decreased 2%, compared to a 5% decrease from October 2009.[9]
Despite these results, as of September 14th, 2010, there was much insider buying which can reflect top management's confidence in the success of the brand - Chairman of the Board, Jay Schottenstein, purchased 500,000 shares; Vice Chairman Roger Markfield purchased 10,000 shares; Director Michael Jesselson purchased 89,800 shares.[10][11]
Figure 2005 2006 2007 2008 2009
Revenue ($millions) 1,890 2,322 2,794 3,055 2,989
Operating margin 19.1% 19.8% 21.0% 19.6% 10.1%
Same store sales growth (decrease) 21% 16% 12% 1% -10%
Store total 846 869 911 987 1,098
[2]
' Fiscal 2005 Fiscal 2006 Fiscal 2007 Fiscal 2008 Fiscal 2009
Stores at beginning of period 846 869 911 987 1098
Stores opened during period 36 50 80 122 29
Stores closed during period -13 -8 -4 -11 -24
Stores at end of period 869 911 987 1098 1103
[1]
Business Segments
AEO currently sells clothing under three brand names: its American Eagle flagship store, its Martin+OSA stores, and its Aerie stores, each of which targets a different demographic or age group.

American Eagle: AEO's flagship brand, American Eagle is a clothing store that sells fashion clothes to 15-25 year old men and women. Selling everything from sweaters and jeans to accessories, American Eagle is the most important brand to AEO. [1]

Aerie: Started by AEO in 2006, Aerie sells intimates and personal care products to 15-25 year old women. With 137 standalone stores and expanding, Aerie sales represent 9% of total sales to AEO's sales mix.[1]

Martin + OSA: A concept store targeted toward selling classic and contemporary clothing to men and women between the ages of 21-60, M+O represent AEO's newest brand. Due to lackluster sales since its inception in 2006, M+O failed to achieve expected sales, posting a loss of $44 million in FY 2008. Though the store posted net income of $50 in the 2009 fiscal year, AEO announced that on March 10, 2010 that it would be closing down its stores to focus on its other brands. [1]

Trends and Forces

AEO is Limited in Their Ability to Anticipate and Respond to Changing Consumer Preferences and Fashion Trends
AEO must identify and respond to fashion trends quickly, which sometimes necessitates predicting popular items. While AEO tries to test the popularity of the items before ordering large quantities, the company cannot be completely successful in predicting trends. This can lead to lower sales, excess inventories, and higher markdowns. In turn, as AEO's loyal customers grow older, they place less emphasis on fashion especially in the style of AEO's target teenage style. As a result, AEO continuously seeks to expand its operations to appeal to more target demographics. However, fashion retail companies have been finding it increasingly difficult to expand their outreach to the older demographic, as evidenced with A&F's closing of its Ruehl stores in 2009 and AEO's closing of Martin + OSA stores in the second quarter of 2010.[12]

American Eagle's Main Sales Seasons Impacted by Recession
Because the overwhelming majority of the customers of AEO's brands age from 15 to 25 years old and are students at some level of education, AEO traditionally experiences a significant boost in sales during the end of summer as students shop in preparation for school. The back-to-school shopping season also boosts sales for AEO's competitors such as Abercrombie & Fitch, Aeropostale (ARO) and Pacific Sunwear of California (PSUN). In addition, the retail industry typically sees a large boost in sales leading up to the holidays in November and December. However, in 2008 the American economy slipped into a recession, which made consumers across all income levels less certain of their financial security. They responded to the increasing economic uncertainty by cutting back on non-discretionary spending. Both the back-to-school and holiday seasons of 2008 have been marked by decreased sales and earnings per share.

Back-to-School: Most of AEO's back-to-school sales are included in the third fiscal quarter (ends in early November). During the 3rd quarter of fiscal 2008, earnings per share dropped 33%[13] and comp store sales decreased by 7% compared to a 2% increase during the same period in 2007.[13] Plus, gross margin decreased 6.4% from the same period in 2007.[13]
Holiday Season: The holiday season occurs during November and December and is part of the fourth quarter of American Eagle's fiscal year. During the 2008 holiday season same store sales declined by 16%%[14] and earnings per share decreased 71%.[14] Although AEO tried to encourage more purchases through the use of promotions, those promotions (such as buy-one-get one 50% off) lowered AEO's margins, leading to the 71% decrease in earnings.
American Eagle Beginning to Expand Internationally
Before the deal with M.H. Alshaya, American Eagle stores were located only in the United States and Canada. This lack of international diversification leaves AEO at the mercy of U.S. economic cycles, meaning a slowdown in spending in the United States will not be offset by sales from another region. Decreasing exposure to the economic cycles of one particular region makes a company more able to withstand recessions and other negative events in those regions. Though a number of clothing retailers have flocked to Asia in order to take advantage of developing wealth there, American Eagle has instead made an agreement to open stores in the Middle East, another wealthy region. By spreading its stores across a wider area, AEO opens itself to new markets and new sources of revenue. On 3/16/2010, AEO opened its first store in Dubai.[15] The firm also plans to open a 9,400 square-foot store in Kuwait City on March 25th, 2010.[15] American Eagle is hoping its connection with M.H. Alshaya will give its clothing lines positive brand recognition going forward.

Increases in Commodity Prices Will Raise Clothing Retailer Prices
In 2010, cotton consumption exceeded cotton production for the fifth year in the row, making cotton prices increase by 80.5% from last year.[16] [17] In 2009, natural disasters also severely damaged crops in many large cotton producer countries, such as China, India, and Pakistan. This led to decreases in cotton exports from these countries and increases in cotton imports as these countries sought to supplement their supply of cotton. [18][19] With limited cotton supplies and rising prices, retailers will either have to absorb these higher material costs, restructure the composition of their clothing to have less cotton, or pass these higher costs to its consumers. Higher clothing prices or lower quality clothing could discourage consumer spending, resulting in decreased net sales. However, adult or teen clothing retailers may not be too adversely affected as their clothing (which is usually 30-40% cotton based) has more flexibility in their composition and thus, costs.

In addition, raising commodity prices in other areas will also raise costs for retailers. The price of shipping a 40-foot dry container from China to the US has increased by 90% since 2009. Lumber and coal prices increased 36.3% and 23.7% from last year, respectively, while oil prices increased by 40% in early 2010 but has now decreased back to a steady single digit increase for the year.[16] While premium price and established brands may be able to pass their higher costs to their consumers, value based companies may not fare as well and may suffer from lower profit margins.[16]

Competition

AEO competes with several other retailers in the 14-30 year old apparel market. AEO has consistently been at the top of its sector in terms of profitability and is one of the largest companies in the market in terms of net sales. AEO's 21.0%[2] operating margin is the highest out of all of its competitors, even considering that its 48.0% gross margin rate is considerably lower than the 66.6% gross margin rate of AEO's main competitor, Abercrombie & Fitch Company (ANF).

American Eagle's competitors include: Abercrombie & Fitch Company (ANF): Abercrombie & Fitch is one of AEO's main rivals. ANF is a larger company than AEO, with a greater store base and higher net sales than AEO. Abercrombie & Fitch Company (ANF) also operates four brands: Abercrombie & Fitch, Hollister, abercrombie, and RUEHL; all of which target different subsets of the 8-30 age range. While AEO's namesake stores compete directly with A&F and Hollister stores, AEO has no match for A&F's kids apparel concept: abercrombie. Although ANF is one of AEO's most direct competitors, the two company's operate with different strategies: Abercrombie maintains a premium brand with high price points while American Eagle attempts to reach a larger range of customers with relatively lower price points on trendy products. Abercrombie & Fitch is planning on closing all RUEHL stores by January 2010.

Aeropostale (ARO): Aeropostale is a smaller company than AEO, with the overwhelming majority of revenue coming from only its namesake brand of stores that targets 14 to 17 year olds. Aeropostale's business model also relies heavily on sales and promotions, something that AEO is trying to move away from in order to keep margins high. Aeropostale (ARO) and AEO compete for the same set of customers, ARO's sales increased 18.5% from 2007 to 2008, a stark contrast to competitors American Eagle and Abercrombie & Fitch, which both reported decreases.

Pacific Sunwear of California (PSUN): Pacific Sunwear primarily serves several different customer segments through its three retail chains: PacSun, demo, and One Thousand Steps. PacSun stores are based mostly around trends in the alternative sports (surfing, snowboarding, skateboarding, etc.) lifestyle and offer third-party branded as well as private label apparel, footwear and accessories to teenagers and young adults.[20] Finally, demo stores target 16 to 24 year olds with fashion and accessories influenced by hip-hop lifestyle and One Thousand Steps offer a wide range of casual footwear to the 18 to 24 year old customer segment.[21]

Urban Outfitters (URBN): Urban Outfitters is a relatively young retailer that operates three different branded store chains, Urban Outfitters (18 to 30 year olds), Anthropologie (30 to 45 year old women), and Free People (16 to 35 year old women).[22] Urban Outfitters is not as directly comparable to AEO due to its slight differentiation in targeted customer segments.

Gap (GPS): Gap is a much larger company than AEO in terms of sales, stores and customer segments targeted. Through variations on Gap (Gap Kids, babyGap, Gap Maternity) the retailer serves a wide range of customers; also, Banana Republic and Old Navy stores serve different socio-economic segments.[23] Because of the wider range of customers, Gap doesn't match up with AEO as closely as some other competitors, however there is considerable overlap.

Company Revenue 2009 (mm) Gross Margin Operating Margin Revenue (Decline) from 2008 Same Store Sales Growth (Decline) Total Stores Sales per Store (thousands)
Abercrombie & Fitch $2,928 64.3% 8.6% (15.9%) (23.0%) 1,098 $2,412
American Eagle Outfitters (AEO) $2,990 38.7% 8.0% 0.5% (4.0%) 1,076 $2,404
Aeropostale $2,230 38.0% 17.2% 18.3% 10.0% 952 $2,206
Pacific Sunwear of California $1,027 25.2% (7.8%) (18.1)% (20.0)% 894 $1,100
Urban Outfitters (URBN) $1,937 40.6% 17.5% 5.6% 7.8% 327 $4,453
Gap (GPS) $14,197 40.3% 12.8% (2.2%) (3.0%) 3,095 $1,332
 
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