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American Eagle (AEO) to Gain From Sturdy Comps, Costs High

Zacks Equity Research

American Eagle Outfitters, Inc. AEO displayed impressive momentum in the past month, driven by a strong top- and bottom-line performance in second-quarter fiscal 2019. On the back of the uptick, the company witnessed further improvement in surprise trend. We note that American Eagle delivered sixth straight positive earnings surprise in the fiscal second quarter, with second consecutive sales beat. Additionally, robust comparable sales (comps) trend in the past few quarters is a key highlight of the company’s growth story.  Positive top- and bottom-line trend can be attributed to strength in American Eagle (AE) and Aerie brands as well as solid growth across stores and digital channels.

These positives have aided the stock to outperform the industry in the past month. American Eagle’s shares have risen 16.9% compared with the industry’s growth of 11.5%.

Despite strong growth trends, investors are wary of the shortfall witnessed in the AE stores during the fiscal second quarter due to colder-than-normal weather. A soft-than-expected earnings outlook for third-quarter fiscal 2019 has hurt investors’ sentiments. Additionally, increased promotions and higher SG&A expenses, which might hurt margins, are headwinds.

Growth Drivers

American Eagle has been witnessing solid comparable sales (comps) for a while, with second-quarter fiscal 2019 marking the 18th straight quarter of positive comps. Despite weather-related challenges at the AE brand, comps benefited from strong performances across AE Jeans, Aerie and the digital channel. Further, it expects strategic actions to sustain comps’ momentum and strong bottom-line trends through the rest of fiscal 2019. Encouragingly, management now anticipates comps to grow in a low to mid-single digit in the fiscal third quarter, driven by improving sales trends.

Moreover, the company is making efforts to develop its omni-channel platform by enhancing its digital portals and investing in store fleet. Backed by its investments in omni-channel capabilities, store and digital channels have been witnessing strong growth for several quarters. In this regard, its digital business continued to exhibit solid growth and contributed nearly 25% to total revenues. Further, digital sales rose in low-double digits, up 100 basis points (bps) from the year-ago quarter’s tally. This mostly offset the decline in stores and drove the top line. Notably, the company is witnessing increases in its app and mobile channels, which together represent more than 50% of the company’s digital business.

Additionally, Aerie brand is touted to be a key growth driver as it is on track to reach the next brand milestone of $1-billion sales. Notably, the brand witnessed comps growth of 16% in the fiscal second quarter, marking the 19th straight quarter (nearly more than four years) of double-digit comps growth. Further, the brand focuses on expanding its market share and customer base. After the success of its core intimates offerings, the brand is rapidly gaining share in the innovative apparel market with the body positivity movement. Moving ahead, the company sees store expansion as an essential tool for enhancing the Aerie brand.

Hurdles to Overcome

Despite these upsides, this Zacks Rank #3 (Hold) company’s AE brand witnessed soft trends in the fiscal second quarter. The brand was hurt by challenges in some of the warm weather-related apparel categories stemming from colder-than-expected weather in May. Consequently, the shorts category missed expectations, while the product mix for women's top was at the lower AUR style. This led to a 1% decline in comps for the brand, which was partly hurt by consolidated comps.

Further, American Eagle witnessed higher markdowns, compensation costs and delivery expenses, which partly offset gross margin growth in second-quarter fiscal 2019.  Moreover, SG&A expenses increased due to escalated compensation expenses. Increased investments in store organization that started mid-way through 2018 and higher professional services fee led to rise in costs. Going ahead, increased expenses might exert pressure on the company’s margins. In fact, it anticipates increased promotional activity and mid-single-digit growth in SG&A expenses in third-quarter fiscal 2019.

Bottom Line

All said, we believe that the stock will gain momentum as it has a long-term impressive earnings growth rate of 6.1% and a VGM Score of A. We expect the company’s brand strength and comps trend to significantly offset margin woes and drive growth in the quarters ahead.

Stocks to Consider

Boot Barn Holdings BOOT has a long-term earnings growth rate of 17% and a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Zumiez ZUMZ has a long-term earnings growth rate of 13.5% and a Zacks Rank #1.

Canada Goose Holdings GOOS has a long-term earnings growth rate of 28.5% and a Zacks Rank #2 (Buy).

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