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Is It Worth Chasing the Rally in American Eagle Outfitters Stock?

Luke Lango

Here’s a headline many of you never thought you’d read: retail is in comeback mode.

Is It Worth Chasing the Rally in AEO Stock?

Source: Mike Mozart via Flickr (Modified)

Don’t believe me? Look at the SPDR S&P Retail (ETF) (NYSEARCA:XRT). It’s up nearly 12% over the past month, versus a 2% gain for the S&P 500.

What is the catalyst? Strong Black Friday and Cyber Monday numbers which underscore that not everyone is shopping on Amazon.com, Inc. (NASDAQ:AMZN).

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By most reports, many retailers experienced strong digital sales growth during that important shopping period, while brick-and-mortar traffic declines finally moderated. Moreover, promotions are peeling back, and margins are starting to stabilize.

These positive Black Friday shopping results have created a rising tide that is lifting all the boats in retail.

One such boat is struggling teen mall retailer American Eagle Outfitters (NYSE:AEO). AEO just reported mixed third quarter results, but that is backward-looking.

More importantly, AEO said it had its best Cyber Monday ever and consequently delivered a better-than-expected holiday quarter guide. Comparable sales growth is expected to accelerate to its best level all year, while sequential margin improvement is expected to continue. Moreover, AEO earnings growth is expected to inflect from negative to positive in the fourth quarter.

Those are big improvements in the AEO growth narrative. And they fit right alongside big improvements in the entire retail growth narrative.

As such, while I’m not terribly bullish on AEO stock specifically, I do think now is a great time to buy beaten-up retail names.

Retail Is Back

AEO’s numbers point to general improvement in the retail space.

Comparable sales growth was 3% in the third quarter. That is as high as that number has been all year. Better yet, comparable sales growth is expected to be about 5% in the fourth quarter (a mid-single-digit rise).

Clearly, sales trends are improving.

Meanwhile, things are also improving on the margin line. Gross margins continue to erode thanks largely to higher shipping costs associated with digital sales, but promotion peel-back is causing those declines to moderate. On the earnings call, management sounded bullish about these sequential gross margin improvements continuing into next quarter and next year.

The operating expense rate continues to fall, representative of AEO’s ability to slim down its operating model while still retaining positive sales growth. Operating margins, which were down big in the first two quarters of the year, fell only 70 basis points in the third quarter. Again, management expects these declines to continue to moderate next quarter and next year.

Overall, AEO earnings growth is expected to inflect from negative to positive in the fourth quarter. That is a big turning point because it illustrates margin stabilization. Margin stabilization on top of positive comps mean that the AEO growth narrative actually has some longevity to it.

AEO Stock Is Good, But Not Great

Alongside AEO, Lululemon Athletica inc. (NASDAQ:LULU), Tilly’s Inc (NYSE:TLYS), Express, Inc. (NYSE:EXPR), Abercrombie & Fitch Co. (NYSE:ANF) and Urban Outfitters, Inc. (NASDAQ:URBN) have all reported positive earnings recently.

They all come together to paint the same picture for retail: sales growth is coming back, margins are stabilizing, and earnings have found a bottom.

This is a rising tide, and AEO stock will rise with the tide.

But it’s not my favorite pick in the group.

Comparable sales growth is trending 2-5% at AEO, while earnings are expected to be flat for the next several years. Meanwhile, AEO stock is trading at 14.8x this year’s earnings.

Over at TLYS, comparable sales growth is roughly similar, but margin improvement is expected to drive earnings growth of almost 10% per year over the next several years. TLYS stock is trading at 24.8x this year’s earnings.

At EXPR, comparable sales growth is negative but improving and expected to turn positive next quarter. Earnings are expected to grow around 13% per year over the next several years. EXPR stock is trading at 23.2x this year’s earnings. The same trend is true with URBN (21.2x this year’s earnings for 8% growth prospects).

So, while AEO stock is cheaper than its mall retail peers, it is cheaper because earnings growth prospects are weaker. As money flows back into this space, I think those inflows will concentrate on the names with more robust earnings growth profiles.

Bottom Line on AEO Stock

While I do like AEO stock, I don’t love it.

It will rise with the rising retail tide, but it won’t be the biggest winner. I’m an owner but more heavily concentrated in other higher-growth-potential names like TLYS and EXPR.

As of this writing, Luke Lango was long AEO, ANF, TLYS and EXPR.

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