Can American Eagle's (AEO) Growth Strategies Pare Cost Woes?

American Eagle Outfitters, Inc. (NYSE:AEO) looks troubled, thanks to high cost-related headwinds that it has been facing for a while now. In addition, investors are wary of soft trends at the American Eagle (AE) stores due to adverse weather conditions. An unimpressive earnings view for third-quarter fiscal 2019 further hurt investors’ sentiments.

Driven by such limitations, shares of the major apparel retailer have lost 32.2% in the past six months, wider than the industry’s 28.4% decline.

Despite the aforementioned shortfalls, American Eagle’s earnings surprise trend remains robust, with the sixth straight quarter of positive earnings surprise in the fiscal second quarter. Additionally, it has displayed a sturdy comparable sales (comps) trend since the past 18 quarters, owing to Aerie’s double-digit comps growth for 19 straight quarters. Moreover, the Zacks Rank #3 (Hold) company’s endeavors — including strength in AE and Aerie brands as well as growth across stores and digital channels — might help it bring back its lost sheen.

Let’s Delve Deeper

American Eagle is witnessing higher markdowns, compensation costs and delivery expenses, which partly offset gross margin growth in second-quarter fiscal 2019. Moreover, SG&A costs increased due to escalated compensation expenses, stemming from higher costs of investment in store organization and higher professional service fees. It anticipates witnessing rise in promotional activity and mid-single-digit growth in SG&A expenses in third-quarter fiscal 2019. These expenses might continue to pressurize margins and hurt profitability.

As mentioned earlier, the company’s AE brand witnessed soft trends in the fiscal second quarter, owing to challenges in some of the warm weather-related apparel categories within the brand on unseasonably colder weather in May. This weighed on the brand’s comps, which partly hurt the company’s overall comps.

Despite robust fiscal second-quarter results, American Eagle envisions adjusted earnings of 47-49 cents for the fiscal third quarter, which fell shy of analysts’ expectations. However, the guidance is in line with 48 cents earned in the year-ago quarter.

While these factors make us apprehensive, let’s take a glimpse of the company’s strategies that are likely to deliver growth.

Talking about strategic endeavors, American Eagle’s solid omni-channel platform is worth mentioning. It constantly develops omni-channel capabilities by enhancing digital portals and store fleet. In the last reported quarter, the company’s digital business continued to exhibit solid growth, contributing about 25% to total revenues. Further, digital sales were up 100 basis points (bps) from the year-ago period. Notably, increases in app and mobile channels together represent more than 50% of the company’s digital business.

Moreover, American Eagle’s investments in store fleet are highlighted by its store-optimization efforts. In fiscal 2019, management intends to open 15-20 AE outlets and 35-40 Aerie stand-alone stores. Also, it expects to remodel 15-20 AE stores while shutting 10-15 AE and 5-10 Aerie stand-alone stores. This makes it clear that in retail, providing the best combination of digital and physical store experiences is a winning marketing strategy.

Strong performance across digital channels, AE Jeans and Aerie, is driving American Eagle’s comps. Notably, AE jeans recorded the 24th consecutive quarter of robust top-line improvement, with double-digit growth in men’s and women’s assortments. Management remains impressed with the robust performance of its fall product across both brands, which started in third-quarter fiscal 2019. Driven by improving sales trends, it anticipates comps to grow in a low to mid-single-digit range in third-quarter fiscal 2019.

Moving ahead, management is confident of sustaining the momentum in Aerie by enhancing the brand’s footprint. Encouragingly, the brand remains focused on expanding market share and rapidly growing customer base.

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