U.S. Markets closed

Why American Eagle Outfitters Has Investment Appeal

- By Robert Stephens, CFA

An increasingly innovative strategy could lead to a successful stock recovery for American Eagle Outfitters Inc. (AEO). The retailer is seeking to differentiate itself from peers by introducing new sizes and materials that resonate with consumers.

It is also seeking to align itself more closely with evolving consumer tastes. Doing so could strengthen its competitive position and help it to post rising profitability.


Although the stock declined 26% over the last year, it seems to offer a wide margin of safety.

1452983000.png

Innovative strategy

An increasing focus on innovation could strengthen American Eagle's financial outlook. It is experimenting with new fabrics, fits and styles that could help to differentiate its products within a highly competitive retail market.

For example, it is in the process of launching a new curvy jean collection for women, which will increase its total addressable market. It intends to stock every size from double zero to 24 in every style in each of its stores. This is expected to increase store traffic as well as create cross-selling opportunities. Likewise, in men's clothing, the retailer is hoping to increase customer numbers through stocking a broader range of sizes, as well as new fits.

As part of its increasingly innovative approach, the company is investing heavily in its manufacturing capabilities. For example, it has invested in laser processing and updated manufacturing techniques that seek to reduce water usage and minimize the impact on the environment. Its use of recycled fabrics in every pair of jeans could resonate with customers as consumers are becoming increasingly aware of the impact clothing manufacturing has on the environment.

Brand appeal

American Eagle Outfitters' continued efforts in increasing its brand appeal could lead to a wider economic moat as a result of improved customer loyalty. For example, it has seen improving customer retention rates and rising spending following its shift toward more inclusive marketing campaigns. They feature untouched ads and models that are more representative of a diverse general population, with this having the potential to boost brand perception among consumers.

The company is also investing in grass-roots campaigns to build customer loyalty. The Camp Aerie pop-up tour and AerieREAL Life content platform allow customers to share their views on how the brand should evolve in the future. This helps to empower customers and may help them to identify to a greater extent with the brand over the long term.

For example, following positive feedback from customers, American Outfitter's jeans recycling program will now be offered throughout the year. A sense of community and having a voice in determining the future direction of the business could create an increasingly loyal customer base.

Threats

Although the tariffs announced to-date are not expected to have an impact on the company's financial results, the potential for further tariffs could weigh on investor sentiment in the short run.

In addition, the company faces the threat of increasing costs, which could further reduce margins. In the most recent quarter, for example, its selling, general and administrative expenses increased 50 basis points as a percentage of revenue to 26%. This was largely due to increased store compensation.

In response to the threat of additional tariffs, American Eagle Outfitters is actively engaging with its sourcing partners to mitigate any potential impacts. As part of these negotiations, it is seeking to diversify its production capabilities across different geographies.

Although the investments it is making in staff pay may increase costs over the medium term, it could also enhance the customer experience. Higher pay may mean lower staff turnover, which could lead to improved customer service levels.

Outlook

American Eagle is expected to grow earnings per share by 9% this year, followed by a 10% increase next year. Since the stock trades with a price-earnings ratio of 11.9, it appears to offer good value.

With the retailer investing in its brand appeal as well as in becoming more innovative, it offers a bright long-term outlook.

Having underperformed the S&P 500 by 28% over the last year, the stock could deliver a successful turnaround.

Disclosure: The author has no positions in any stocks mentioned.

Read more here:



Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here .

This article first appeared on GuruFocus.