Shares of American Eagle Outfitters (NYSE:AEO) are trading sharply higher on Wednesday ahead of the company’s highly anticipated fourth-quarter earnings report. As of this writing, AEO stock is up more than 5% ahead of earnings.
The reason for the pre-earnings move higher in AEO stock? Mall retail peers Abercrombie & Fitch (NYSE:ANF) and Urban Outfitters (NASDAQ:URBN) have both reported strong holiday quarter numbers over the past 24 hours.
The broad takeaway from all those reports? The retail environment remains healthy right now, defined by positive comparable sales growth and stabilizing to improving margins.
For a long time, American Eagle has differentiated itself as one of the best retailers in an otherwise troubled retail landscape due to its unique product offering, high brand equity, and red-hot Aerie business. Now, that retail landscape is dramatically improving. This is a rising tide that will lift all boats, American Eagle included.
As such, American Eagle’s fourth-quarter numbers should be quite good. With AEO stock trading at just 13 forward earnings ahead of those numbers, the valuation is reasonable enough to support a fairly sizable post-earnings rally in AEO stock. As such, it looks likely that AEO stock pops after the bell on Wednesday.
All Signs Point to a Beat-and-Raise Quarter
Everything I’m looking at implies that American Eagle is set to report a beat-and-raise fourth-quarter earnings report after the bell.
First, we already know American Eagle had an awesome holiday season. AEO reported in early January that fourth-quarter comparable sales were up 6% quarter-to-date, an impressive mark, especially against a tough up-8% lap. It’s unlikely that comparable sales trends have slowed since then, considering that consumer confidence has only improved since the holidays as financial markets have stabilized.
Second, mall retail is firing on all cylinders right now. Mall retail peers Urban Outfitters and Abercrombie & Fitch both reported strong fourth-quarter numbers that included positive and healthy comparable sales growth alongside margin improvements. Abercrombie & Fitch management also delivered a really healthy fiscal 2019 guide. American Eagle’s numbers tend to track Urban and Abercrombie’s numbers, which makes sense given the heavy overlap in product type, real estate, and target demographic. As such, strong sales and margin numbers at URBN and ANF imply that AEO could be due to report equally strong sales and margins numbers.
Third, the whole retail scene is firing on all cylinders, too. Urban Outfitters and Abercrombie & Fitch weren’t the only retailers to report strong holiday sales and margin numbers. Walmart and Target did, too. As did Ross Stores. And many more. Across the board, the read on the retail landscape right now is that sales trends are improving, margins are stabilizing, and healthy profit growth is coming back into the picture.
Fourth, it looks like American Eagle continues to grow market share. The only mall retail name that hasn’t reported great numbers this holiday season is L Brands (NYSE:LB). Specifically, Victoria’s Secret reported weak holiday numbers, with fourth-quarter comparable sales dropping 3%.
Over the past several years, as Victoria’s Secret has struggled to sell bombshell beauty products, American Eagle’s Aerie brand has grown by leaps and bounds through selling natural beauty products. It appears this trend is still alive and well, meaning Aerie could be due to report another monster quarter.
The Valuation Supports a Rally
All the data points imply that American Eagle is set to report a very good quarter defined by healthy comparable sales growth and healthy margin expansion. But, will those strong numbers be enough to cause a rally in AEO stock?
They should. AEO stock is trading at just 13 forward earnings. That is a below average multiple, both across the whole market and for apparel retail stocks. Thus, AEO stock trades at a relative discount, meaning that if American Eagle does report strong Q4 numbers, those strong numbers will converge on a discounted valuation. That convergence almost always causes stock rallies.
As such, it appears that not only is American Eagle ready to report good numbers, but it also appears that those numbers will be good enough to spark a rally in AEO stock.
Bottom Line on AEO Stock
Everything points to American Eagle reporting strong holiday quarter numbers. If so, the valuation is low enough to warrant a big post-earnings rally in AEO stock. As with all earnings plays, this is a risky situation that could the other way. But, the risk-reward profile rests on the side of the bulls.
As of this writing, Luke Lango was long AEO, TGT and ROST.
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