Why Buying American Eagle Stock May Not Be So Crazy

The headlines make a pretty compelling case as to why all might not be as it seems in the retail world. For all the good economic news in the e-commerce world, it’s been a mixed bag for brick-and-mortar retailers. Those that are cracking the omnichannel code, such as Target (NYSE:TGT) are flourishing. Other stores like Kohl’s (NYSE:KSS) continue to face challenges.

A common denominator for the brands that are delivering bad economic news is a reliance on mall traffic. That would seem to say that investors should ignore American Eagle Outfitters (NYSE:AEO) stock and its 934 stores. The company’s earnings report, released on December 11 did little to add encouragement.

Although earnings were in-line with analysts’ expectations and revenue was up 6.2% on a year-over-year basis, it’s the rest of the story that is causing AEO stock to continue its steady decline. The revenue gains are being driven, in part, by deep discounting. That has put pressure on the company’s margins. It’s also a significant reason the company lowered its fourth-quarter guidance.

But there are still reasons to be optimistic about the company and its stock.

American Eagle Remains Very Popular With its Core Demographic

In its 2019 survey of teen spending habits, Piper Jaffray found that American Eagle ranked as the second favorite clothing brand for teenagers below only Nike. Part of the brand’s popularity is its “brand inside a brand”, Aerie, which markets body-positive messages.

This body-positive messaging is also paying off as American Eagle continues to gaining market share in its all-important denim category. It has posted 23 consecutive quarters of record jean sales. It is also the leading women’s brand in the United States as well as for men ages 15-25. Their inventory includes a range of sizes and cuts including “curvy” jeans, high-waisted jeggings, and flares.

And American Eagle is enticing this demographic with their introduction of a “buy now” pay later installment plan program. Revenue numbers would suggest the program may be providing a boost, but it remains to be seen if the program can sustain itself when deep discounting is removed from the equation.

Christmas may come late for American Eagle

I’m not referring to the shortened holiday season. I’m always a little skeptical when companies cite things like weather or a shortened calendar to explain a lack of sales. What I mean for American Eagle is that they are likely to benefit from a post-Christmas sales boost. The reason? Gift cards and holiday cash. Teenagers, which make up AEO’s core audience, want to buy their own clothes thank you very much. For these consumers, cash is king.

So while American Eagle stores may not be getting the desired foot traffic during the holidays, I expect consumers will be visiting stores and shopping online as they look to put that holiday cash to good use. However, many of these sales will not be recorded until the first quarter of 2020.

American Eagle’s operational costs will be coming down

According to UBS, over the next several years American Eagle will receive anywhere from a 5% to 20% decrease in rent in their Class C malls. These are malls with high vacancy rates and lower traffic than higher-tier malls.

The company is also saying they are making efforts to reduce the amount of goods they import from China from 30% to 20%. Whether or not they can actually do that remains to be seen. However, it may provide investors with the hope that the company may be less affected by any prolonged trade dispute.

 Why Investors May Want to Wait Until the New Year to Buy AOE Stock

If I were to be bearish on AEO stock, I would point out that the company faced problems in their second-quarter earnings as well. Comparable store sales were down markedly from the first quarter. Both then and now, American Eagle CEO Jay Schottenstein has said the company is taking “quick action” to remedy the problem.

But the reality is there’s not much they can do. Part of which is attributable to the ongoing trade war with China. It seems like a tired story I know, but many retailers pre-ordered inventory in advance of the September 1 tariffs. Those tariffs were extended to December 15. Subsequently many have ordered early for next year because of uncertainty surrounding that deadline which has now been extended. But not necessarily canceled. This is creating uncertainty for investors, particularly as American Eagle imports approximately 30% of its goods from China.

This means that, aside from reducing the amount of goods they import, there is no easy solution to American Eagle’s inventory glut. And that means that the company will likely face a less-than-jolly holiday season.

Having said that, I do think that American Eagle is an example of a good brand that is being oversold. Look at the technical indicators to find a good price to enter, but with the stock trading at two-year lows, it looks like it may be finding support.