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Will American Eagle's Growth Plans Combat Soft Margins?

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Popular apparel and accessories retailer, American Eagle Outfitters Inc. AEO is benefiting from solid strategies like enhancing product assortments; managing inventories efficiently and boosting e-commerce business. These efforts helped the company make a comeback in second-quarter fiscal 2017, alongside retaining its sturdy comparable store sales (comps) trends.

However, in the process of keeping pace with the changing consumer environment and battling stiff industry competition, the company is witnessing strained margins. So, let’s see if American Eagle’s growth drivers will be enough to offset these hurdles, and help the company keep its growth story intact.

American Eagle’s Growth Endeavors On Track

Given Amazon.com Inc.’s AMZN growing control and consumers’ rapid shift to online shopping, retailers are firing on all cylinders to tap sales. Many apparel companies like Abercrombie & Fitch Co. ANF and The Gap, Inc. GPS have resorted to the omni-channel strategy. Likewise, American Eagle too remains focused on strengthening its product assortments by adding more compelling brands, managing inventory levels diligently and improving e-commerce business.

Moreover, it remains committed toward enhancing store sales by rationalizing its brick and mortar store fleet that includes closing underperforming stores and expanding the profitable ones. In sync, the company recently announced plans to close about 25-40 stores in fiscal 2017. Additionally, it targets opening 10 outlets (including five AE and Aerie stores, each) across the United States, Canada and Mexico through the rest fiscal 2017, as well as 32 international licensed stores.

Further, it remains on track to launch the revamped loyalty program that is likely to convert more than 15 million current metrics and attract new customers with a seamless overall experience. This completely digital program will be fully integrated across shopping channels, enhancing customers’ shopping experience. Also, American Eagle has been improving its website as well as mobile app to develop its omni-channel platform. Notably, these endeavors helped American Eagle’s e-commerce sales to contribute about 23% to total revenues in second-quarter fiscal 2017.

Factors That Drove Q2 Performance

While the quarter marked second straight quarter of sales beat, earnings topped estimates after a miss in the last quarter. The company also posted 10th straight quarter of positive comparable store sales (comps) backed by strong online sales at both the brands driven by efficient use of omni-channel capabilities to enhance customer experience. Results also gained from strength in the aerie brand, which posted 14th straight quarter of double-digit comps growth. Moreover, the company is optimistic about the second half of fiscal 2017, particularly the fall season.

Strained Margins: A Major Concern

While retailers remain committed toward strategies like optimizing store fleet and boosting e-commerce sales, consumers’ evolving preferences and mounting industry competition have forced them to undertake intense promotions to clear inventory. American Eagle is not safe from this trend. Though American Eagle’s second-quarter fiscal 2017 marked a comeback, margins continued to be under pressure due to increased promotional activities to counter sluggish mall traffic.

The company’s adjusted gross margin contracted 240 basis points (bps) in the second quarter, while operating margin shriveled 230 bps. The downturn was mainly accountable to greater promotional activity, alongside a rise in buying, occupancy and warehousing costs, and higher SG&A expenses. Going forward, the company expects the soft margin trends to continue and hurt results in the fiscal third quarter, as evident from its recent guidance. For the fiscal third quarter, the company projects soft merchandise margins due to intense promotional activities. Moreover, it anticipates SG&A expenses to increase in low-single digits.

So, What’s in Store for American Eagle?

Nevetheless, American Eagle is focused on undertaking initiatives to reduce costs through supply chain efficiencies and its updated product allocation system. We believe that all aforementioned initiatives should help the company combat the hurdles and drive profitability.

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