American Eagle Outfitters, Inc.

Moat: 1.5/5

Understandability: 2/5

Balance Sheet Health: 3/5

American Eagle Outfitters, Inc. is a global specialty retailer offering high-quality, on-trend clothing, accessories, and personal care products primarily under the American Eagle and Aerie brands.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview American Eagle Outfitters (AEO) operates a global specialty retail business, primarily targeting a younger demographic, offering apparel, accessories, and personal care products under its American Eagle and Aerie brands. The company operates over 1,000 stores primarily in the U.S, Canada, Mexico, Hong Kong, and Japan along with an omni-channel presence that includes its online platform. AEO’s merchandise is both developed in-house and secured through agreements with its overseas manufacturing and distributing partners.

Revenue Distribution: AEO’s revenue streams can be broken down into the following categories:

  • American Eagle Brand: The core brand focusing on apparel and accessories, mostly targeted at a younger male audience.
  • Aerie Brand: This is a fast-growing brand focusing on intimates, apparel, and lifestyle products targeted towards a younger female audience.
  • AEO Direct: Online sales made through its website or apps, including international ecommerce.
  • Other: Revenue from licensed operations and other revenue streams. Geographically, a significant portion of revenue is generated in North America, but the company has a growing presence internationally.

Industry Trends & Competitive Landscape: The apparel retail industry is highly competitive and subject to constant change. AEO faces competition from other specialty retailers, department stores, online retailers, and emerging fast fashion brands. The company is impacted by changing consumer preferences, including the rise of online shopping, the pursuit of value, and the increasing importance of sustainability and ethical sourcing. The industry’s current macro economic climate has been challenging. In Q1 2024, consumers were hesitant to spend. Inflation, a shift in spending to services, and a reduction in discretionary income hit the discretionary segment of the retail market hard. The competition is high and continues to increase, and also includes other major apparel retailers and new online entrants.

Financials Overview AEO’s financial performance has been mixed. The third quarter results had a positive trend of revenue and profit growth. In addition to top-line growth, AEO continues to focus on its profit-improvement initiatives.

  • Net Revenue: The company reported a third-quarter net revenue of $1.28 billion, compared to $1.24 billion last year. Total revenue for the 39-week period ending October 28, 2023 was $3.76 billion, compared to $3.73 billion last year. The increase in revenue was primarily driven by American Eagle and Aerie brand revenue and an increase in delivery revenue. This revenue increase is mostly driven by a higher transaction volume.
  • Gross Profit: The gross profit increased by 3.9% in the last quarter to $493 million, which primarily benefited from lower transportation and product costs.
  • Operating income: Operating income was $144 million for the last quarter. For the nine-month period of fiscal year 2024, American Eagle Outfitters’ operating income is $357 million compared with a loss of $13.2 in the same period in the prior year.
  • Net income: Net income for the last quarter was $77.3 million, an increase from $37.9 million compared to last year. For the nine months ended October 28, 2023 Net Income is $225 million. The net income for the three quarters of fiscal year 2023 was negative at $170 million.
  • Gross Margin: Improved to 38.3% from 36.7% in the prior year because of lower freight and product costs.
  • Inventory: The company continues to manage its inventory well, which has led to better store-level profitability.
  • Debt: AEO is in a good position to tackle debt. They had a very small amount of interest expense, and were able to pay down $150 million in debt this year, and they expect to pay down more debt in the future.

Recent Challenges:

  • AEO has been facing difficult market conditions characterized by decreased consumer spending and changing preferences. There is also a risk that the business environment could continue to be volatile due to economic conditions.
  • The company has had some major cost-cutting efforts by laying off employees and reducing capital expenditures. They plan to continue to evaluate the cost structure and keep control of operating costs.
  • A major concern going forward is if AEO will still be able to maintain its margins as competition continues and pressure for price decreases increases.

What Makes AEO Different

  • Strong Brands: American Eagle and Aerie have good brand recognition, particularly among younger demographics.
  • Omni-Channel Presence: The company has a good online presence. Both their website and their store operations are successful and work in conjunction.
  • Customer Loyalty Program: The company has a successful loyalty program, which creates customer retention and is seen as a competitive advantage.

Moat: 1.5 / 5

AEO has a very weak moat. The lack of a strong, durable competitive advantage puts it at risk from competition and disruption. The core issues for AEO are the low switching costs for customers, brand recognition is not unique and other brands can compete with AEO, and the business doesn’t rely on proprietary technology. Let’s break this down.

  • Switching Costs (1/5): Customers can easily switch between apparel retailers, both online and in brick-and-mortar stores, which makes it hard for AEO to build loyalty.
  • Intangible assets (3/5): Both Aerie and American Eagle have somewhat high brand recognition amongst a particular younger demographic, however, they do not have pricing power as a result. In this highly competitive industry, brands are often substitutable for one another.
  • Network Effect (1/5): The business does not benefit from any network effects.
  • Cost Advantages (2/5): The company is working to improve its costs and inventory control, however, it doesn’t have a special advantage stemming from the process, location, scale, or access to unique assets.
  • Size Advantage (1/5): The market is filled with large competitors and even the larger players like AEO does not have any special advantage.

Legitimate Risks to the Moat:

  • Changing Consumer Preferences: Trends and fashion tastes change rapidly and AEO needs to keep up with them. A change in consumer taste may make the current brand less appealing and the value of the brands will diminish.
  • Increased Competition: The apparel retail market is heavily contested and the business faces fierce competition from both legacy brands and new, fast-fashion players. As the market becomes more competitive, profit margins will decline.
  • Weakening Brand: AEO’s brand might lose relevance, or not remain as attractive if its products do not keep up with the latest trends. This will hurt the pricing power and long-term profitability.
  • Economic Downturn: A worsening economy could reduce consumer discretionary spending, which could hurt AEO’s ability to grow and maintain its profits.
  • E-Commerce Threat: Online retailers are increasing their market share and could take market share away from physical retailers.
  • Global supply chain disruptions: Supply chains face constant threats from geopolitical issues and other global economic conditions. If these disruptions occur, AEO could find it difficult to source raw materials, which will ultimately lead to higher prices and make it difficult to produce and sell goods.

Business Resilience: AEO has shown some resilience by cutting its costs, managing inventory better, and improving its digital platform. They are also focusing more on their direct-to-consumer segments. Despite these strengths, AEO does not have a unique product or economic advantage that could make it weather any downturn better than its peers. The ability of management to quickly adjust to changing circumstances is what will be critical.

Understandability: 2/5

AEO’s business model is fairly straightforward to understand, yet its financial performance and future outlook have numerous factors making analysis a little challenging.

  • Business Model Complexity: The basic operation of the business is easy to understand-the selling of clothing products. The business model is also not that complex, as the focus is mainly on the American Eagle and Aerie brands, with other sales channels contributing to smaller portions of the overall revenue.
  • Financial Statement Complexity: Although the financials themselves are easy to understand, the underlying nature of the industry with many costs and changing consumer preferences makes forecasting difficult.
  • Industry Dynamic Complexity: While the operations may be simple, figuring out the future for any retailer in the fashion industry is inherently complex. Fast-changing consumer preferences, the growth of e-commerce, and strong competition makes the long-term profitability more complicated to foresee.
  • Competitive Landscape Complexity: Intense rivalry between many players, including the threat of new entrants makes the financial analysis more challenging.
  • Economic Influences: Consumer discretionary spending, inflation and changes in global supply chains are large macro economic factors that could have a meaningful effect on AEO, making it harder to estimate what can happen in the future.

Balance Sheet Health: 3 / 5

AEO has a relatively good balance sheet, however, there are some areas of concern.

  • Cash and Liquidity: AEO has an adequate cash and cash equivalent balance, however, the company does have a large amount of inventories.
  • Debt levels: AEO has successfully paid down debt, which has reduced interest expense. Debt is below book value. However, long term debt is still present.

  • Working Capital: AEO’s inventory levels have increased this year, but are within a reasonable range and have mostly been used to create higher revenues. The inventory to sales ratio is also within reasonable bounds.

  • Liabilities: The company’s total liabilities, which are at 44% of total assets are moderate and can be easily managed given the current level of sales and asset utilization.

Despite these positives, the company has seen a negative trend in its assets. Overall, AEO does have a reasonable balance sheet, that can be improved to reflect more financial stability.