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American Eagle Down 22% in 3 Months: Is a Turnaround Likely?

Zacks Equity Research

American Eagle Outfitters, Inc. AEO stock has been in the doldrums in the recent past. Shares of the company have tumbled 22.2% in the past three months, wider than the industry’s 18.7% decline. The stock also underperformed the broader Retail-Wholesale sector and S&P 500’s respective growth of 2% and 2.2%.

We note that the stock was hit by the company’s bleak earnings outlook for second-quarter fiscal 2019. Adjusted earnings are envisioned to be 30-32 cents for the impending quarter, down from 34 cents recorded in the year-ago quarter. Additionally, American Eagle witnessed strained margins in the fiscal first quarter, which further affected investor’s sentiment.

Factors Hurting Stock Performance

In first-quarter fiscal 2019, higher markdowns and delivery expenses dented American Eagle’s gross margin, which coupled with higher SG&A expenses hurt operating margin. While gross margin contracted 30 basis points (bps) in the reported quarter, operating margin was down 80 bps.

We note that the company has been witnessing strained operating margin since the last few quarters, primarily due to higher SG&A expenses. Rise in SG&A expenses can be mainly attributed to higher investments in brands and initiatives to enhance customer experience as well as higher store payroll, wages, and increased incentive expenses and advertising costs.

Following the management’s soft earnings view for second-quarter fiscal 2019, analysts are pessimistic about American Eagle’s results in the upcoming quarter. Apparently, the current Zacks Consensus Estimate of 32 cents for the second quarter was revised 5.9% downward over the past 30 days.

Strategic Endeavors Might Aid a Turnaround

Despite the odds, American Eagle’s efforts to strengthen omni-channel endeavors and Aerie brand appear impressive.

American Eagle is striving to develop its omni-channel platform by enhancing the digital portals besides investing in store fleet. Digital sales grew in low-double digits, with the business contributing about 30% to total revenues in first-quarter fiscal 2019. This represents 100 bps growth from 29% recorded in the year-ago quarter. Notably, the company is experiencing increases in its app and mobile channels, which together represents more than 50% of its digital business.

Additionally, trends in brick-and-mortar stores continued to improve as both the company’s AE and Aerie brands’ stores reported positive in-store comps. Notably, American Eagle reported positive in-store comps for the sixth consecutive quarter.

American Eagle’s comps grew 6% in the first quarter. Brand-wise, comps rose 14% at Aerie stores and 4% at AE outlets. Notably, the AE brand is gaining from its leadership position in bottoms, with jeans business recording 23rd consecutive quarter of comps growth.

Aerie has evolved into a lifestyle brand, and remains focused on expanding market share and rapidly growing 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. Encouragingly, American Eagle plans to accelerate the brand’s footprint by opening 35-40 Aerie stores in fiscal 2019.

These apart, American Eagle boasts a robust comparable sales (comps) trend, marking 17th straight quarter of comps growth in first-quarter fiscal 2019. The company also delivered fifth straight quarter of positive earnings surprise, with a sales beat in four of the trailing six quarters.

Backed by these positives, we expect this Zacks Rank #3 (Hold) stock to consistently deliver growth in the coming days.

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