1 Question American Eagle Outfitters Has to Answer Before I Cash Out

American Eagle Outfitters (NYSE:AEO) has been a standout player in the retail apparel market over the past year. Its stock price rallied more than 50% over the past 12 months, even as the pandemic shut down its stores, and it recently reinstated its dividend after suspending it in April.

The bulls believe AEO will gain more shoppers from bankrupt competitors, its Aerie lingerie and activewear brand will continue growing, its digital sales will remain robust, and its business will stabilize as more people are vaccinated. That outlook is rosy, but the bulls often overlook AEO’s original weaknesses. Prior to the pandemic, AEO’s comparable-store sales growth had been decelerating and its margins were declining.

A young woman turns around on a downtown street.

Image source: Aerie.

I’ve considered taking profits in the AEO stock I own after its year-long rally, since fresh waves of infections, new variants of the coronavirus, and problems with vaccines could still prompt more shutdowns over the next few months. However, I’m going to hold off on that decision until after AEO’s virtual investor meeting on Jan. 21. In this meeting, I hope AEO can answer a simple question: Will it overcome its older problems after the pandemic, or will they resurface?

American Eagle Outfitters’ original problems

American Eagle was one of the few mall-based retailers that generated positive comparable store sales growth throughout the retail apocalypse. Its total comps rose for 20 straight quarters through the fourth quarter of 2019, but its American Eagle and Aerie brands were both gradually losing their momentum.

Data source: AEO quarterly reports.

American Eagle generated strong sales of jeans and bottoms throughout 2018, but soft demand for tops and tepid sales of warm-weather apparel during a cooler summer throttled its sales in 2019. Aerie’s growth remained robust, and it seemingly pulled customers away from struggling competitors like L Brands(NYSE:BBWI) Victoria’s Secret, but most of its growth was offset by American Eagle’s slowdown.

Meanwhile, AEO’s gross and operating margins both declined significantly in 2019, mainly due to bigger markdowns and higher delivery costs:

Metric

FY 2017

FY 2018

FY 2019

Gross margin

36.1%

36.9%

35.3%

Adjusted operating margin

8.6%

8.4%

7.3%

Data source: AEO quarterly reports.

AEO’s slowing growth and declining margins caused its stock to decline 24% in 2019, which erased its 27% growth over the previous two years. That slowdown also sparked concerns that AEO was merely one of the final victims of the retail apocalypse instead of a resilient survivor.

American Eagle Outfitters’ new problems

The pandemic shut down most of AEO’s stores in the first half of 2020. It stopped reporting its comparable store sales due to the store closures and merely reported its total revenue — which fell 18% year over year in the first nine months.

Data source: AEO quarterly reports.

But American Eagle’s business has been gradually recovering, with strong digital sales offsetting its slow mall traffic, sales of its tops improving with new styles and fabrics, and demand for its jeans remaining high.

Aerie’s growth also turned positive in the second quarter and accelerated into the third quarter, as strong digital sales and aggressive social media engagement campaigns — which aggressively target Victoria’s Secret with body-positive ads — locked in more shoppers.

AEO’s gross and operating margins contracted significantly in the first half of the year as its stores closed down, but stabilized and expanded in the third quarter:

Metric

Q1 2020

Q2 2020

Q3 2020

Gross margin

5.1%

30%

40.2%

Adjusted operating margin

(36.7%)

0.3%

9.9%

Data source: AEO quarterly reports.

AEO attributed that recovery to fewer promotions, more full-priced sales, and lower product costs. Those improvements all offset the higher fulfillment costs for its digital business, which generated 45% of its revenue in the first nine months of the year.

Will American Eagle Outfitters continue to recover?

AEO seems to have resolved many of its prior problems, even as it faced unprecedented challenges throughout the pandemic. Hopefully, the company will provide a positive outlook for the fourth quarter and 2021 — and convince investors it won’t sink back into the doldrums of 2019.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.


View more information: https://www.fool.com/investing/2021/01/21/1-question-american-eagle-outfitters-has-to-answer/

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