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American Eagle Outfitters_ Inc AEOS

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					American Eagle
 Outfitters, Inc.
     AEOS


          By, Matthew McDonnell1
          Presented 11-15-2005
                        Outline
• Today, I will be discussing American Eagle Outfitters, Inc.
  (AEOS), which is currently a major part of our client’s
  portfolio.

• In addition to evaluating the firm itself, I will briefly
  compare American Eagle Outfitters to some of its major
  competitors.

• Third, I will discuss several stock valuation methods, as
  well as other issues facing the firm.

• Finally, I will give a recommendation regarding what
  should be done, if anything, regarding our holdings in
  American Eagle Outfitters.
                                                              2
           Macroeconomic Review

• Currently middle of earnings seasons
• Energy prices, although falling, still at relatively
  high levels
• Rising interest rates affecting markets
• Energy-driven inflation, questionable consumer
  confidence
• Many retailers reported slow start to 05 holiday
  season, sales now growing stronger



                                                         3
   American Eagle Outfitters- Vision

• “We will be a highly profitable,
  international, multi-channel retail
  organization”

• “We will grow through a portfolio of our
  own distinct and segmented casual
  lifestyle apparel brands”


                                                                                                                                        4
            Source: American Eagle Outfitters- Latest Wall Street Presentation, Oct. 27, 2005. available at http://library.corporate-
            ir.net/library/81/812/81256/items/169479/Latestwebsitepresentation.pdf
   American Eagle Outfitters- Industry
            Classifications
Sector: Consumer Discretionary
  Industry Group: Retailing
     Industry: Specialty Retail
           Sub-industry: Apparel Retail
     Industry: Multiline Retail
           Sub-Industries: Internet Retail,
                            Catalog Retail



                                                                                                                                                        5
         Adapted from: Standard and Poor’s GICS Map, effective Apr. 30, 2005, available at javascript:popup('/spf/xls/index/gics_map_April_2005.xls')
    American Eagle Outfitters- GICS
          Sector Description
Consumer Discretionary Sector:
      “The GICS Consumer Discretionary Sector
 encompasses those industries that tend to be
 the most sensitive to economic cycles. Its
 manufacturing segment includes automotive,
 household durable goods, textiles & apparel and
 leisure equipment. The services segment
 includes hotels, restaurants, and other leisure
 facilities, media production and services, and
 consumer retailing and services.”1
                                                                                                                           6
                   1 Standard and Poor’s GICS Industry Classification Definitions, effective Apr. 30, 2005 available at:
                   javascript:popup('/spf/pdf/index/GICSSectorDescriptions_April2005.pdf')
  American Eagle Outfitters’ Business

• American Eagle is a “leading lifestyle retailer that
  markets and sells [its] own brand of relaxed,
  casual clothing.”
• Target audience: 15-25 year-olds
• Operates 846 stores in the US & Canada
• Located primarily in malls, with emphasis on “A”
  center stores in especially high-traffic areas
• Purchases merchandise from suppliers who
  either make it themselves or buy from
  producers.

                                                                                                             7
                            Source: Corporate Profile- About AE, American Eagle Homepage, accessed Nov. 07,
                            2005, available at: http://phx.corporate-ir.net/phoenix.zhtml?c=81256&p=irol-homeprofile
            American Eagle Outfitters- Products
                          Sold
                                  2004 Sales Breakdown
                                                                                      Men's apparel &
                                  5%
                                                                                      accessories
                                               34%
                                                                                      Women's apparel
                                                                                      & accessories
                         61%                                                          Footwear- men's
                                                                                      and women's
        2002-2003 Change in Sales Composition                2003-2004 Change in Sales Composition
10%                                                    4%
                             5%                                                      2%
 5%                                                    2%
                                             0%                                                                0%
 0%                                                    0%
       Men's apparel &    Women's      Footwear- men's       Men's apparel &   Women's apparel &      Footw ear- men's and
-5%                                                    -2%    accessories        accessories                w omen's
        accessories       apparel &     and women's
-10%        -8%          accessories                  -4%         -3%
                                                                                                                                8
                                                                                    Source: American Eagle 2004 Annual Report
American Eagle Outfitters- Locations By State




                                                                    9
                             Source Data: American Eagle Homepage
                             Map from Yahoo! Travel
   American Eagle Outfitters- International
               Sales Base
                       International Sales Base- 2004
                                   Foreign
                                     7%




                                             U.S.
                                                             Change In International Sales Base
     Change In International Sales Base      93%
                                                                         2003-2004
                 2002-2003       Foreign
                                 18.28%
20.00%
                                                    15.00%
10.00%                                                                                              Foreign
                                                    5.00%                                            3.12%
 0.00%
                U.S
                 1                 2                                 U.S
-10.00%                                             -5.00%            1                                  2
              -1.09%                                               -0.22%
                                                                                                                10
                                                                    Source: American Eagle 2004 Annual Report
American Eagle Outfitters- Brand
          Positioning




                                                                                                                                   11
       Source: American Eagle Outfitters- Latest Wall Street Presentation, Oct. 27, 2005. available at http://library.corporate-
       ir.net/library/81/812/81256/items/169479/Latestwebsitepresentation.pdf
    American Eagle Outfitters- 2004
          Accomplishments
• 31% increase in sales (21% comparable
  store sales)
• 171% increase in operating income
• Nearly doubled market share in specialty
  denim
         » 2nd most purchased brand by target market
• Increased US store base by 5%
         » 40% of new stores on the West coast



                                                                                   12
                                       Source: American Eagle 2004 Annual Report
   American Eagle Outfitters- 1st Half
          2005 Performance
• Significant gains in teen brand popularity
  – Seen as “3rd coolest brand for teens”
  – Second most often shopped specialty brand for denim
• Comparable store sales up 20% over 1 st half
  2004
• 80% growth in EPS
• Slow start to holiday season, downgraded Q3
  earnings, later upgraded to original projections
  of $0.45-$0.46 per share

              Sources: American Eagle Outfitters- Latest Wall Street Presentation, Oct. 27, 2005. available at http://library.corporate-   13
              ir.net/library/81/812/81256/items/169479/Latestwebsitepresentation.pdf
              American Eagle Outfitters, Form 8-K filed Sept. 20, 2005
American Eagle Outfitters- Looking Forward
       Plans for 2005 and Beyond
• Expansion
  – New “flagship stores in NYC, Seattle”
  – Expansion into Alaska, Hawaii, Canada, Puerto
    Rico
  – Still focused on Western, Southwestern US
     • Evidenced by purchase of new distribution facility in
       Ottawa, K.S.


• New operating system used to streamline
 distribution
                                                                                       14
                                Source: American Eagle Outfitters 2004 Annual Report
American Eagle Outfitters- Looking Forward
                (cont.)
  One of American Eagle’s most significant plans for the
   future is the recent unveiling of its new brand, Martin
                          and Osa
 • Unveiled 10/20/2005, Scheduled to debut in malls in Fall,
   2006
    – Will operate as its own business segment separate of American
      Eagle brand.
 • Targeted to men, women age 25-40
    – This is outside AE’s traditional 18-25 market
    – Possibly explains move to Southwest US
 • Will include “classic sportswear”
    – Described by "a union of everything that is right about classics,
      denim, and active sportswear”
    – Using former Abercrombie & Fitch designers to head project

                                 Source: American Eagle Outfitters Announces Name of New Concept: MARTIN + OSA,
                                                                                                                         15
                                 American Eagle Homepage, accessed Nov. 1, 2005, available at: w ww. http://phx.corporate-
                                 ir.net/phoenix.zhtml?c=81256&p=irol-new sArticle&ID=770357&highlight=
American Eagle Outfitters- Financial
            Analysis
Items of note include:
1. Increasing Liquidity
     -- ↑Current Assets, ↓Non-current Assets
      –     Possible Implications: planned expansion,
            anticipation of bad season.


2.   Decreasing COGS as % Net Income
     – Implication: Irregularities with respect to
       inventory management/sales
     – Stainable decline? Not likely.


                                                        16
American Eagle Outfitters- Stock
Performance vs. S&P 500 (5yrs)




                                   17
 American Eagle Outfitters- Stock
Performance vs. Competitors (5yrs)




                                     18
American Eagle Outfitters’ Competitors

•   The Limited
•   The Gap
•   Abercrombie & Fitch
•   Aeropostale
•   Pacific Sunwear




                                     19
 American Eagle Outfitters- Comparable
            Performance


                   ANF        GPS       PSUN      AEOS      Industry
Forward P/E           12.69       12.07     12.97    10.69*       9.18
Profit Margin       10.40%       7.43%     6.29%    11.34%     12.83%
Operating Margin    18.24%      12.25%     9.84%    19.33%     20.91%
ROE                 27.42%      22.46%    18.01%    29.79%     29.79%
ROA                 17.14%      12.93%     9.18%    22.96%     22.96%




                                                                                                               20
                                       Competitor Data: Yahoo! Finance, accessed Oct. 27, 2005, available at
                                       http://www.finance.yahoo.com
 American Eagle Outfitters- An RCMP
              Holding
• Bought on 3 occasions: 12/1999, 03/2000,
  05/2000
• Sold 25% of holdings in 04/2005
• As of Nov. 7, 2005, AEOS constituted 9% of the
  portfolio’ book value and 20% of the portfolio’s
  market value.
• Since its initial purchase, the stock price has
  climbed 329%
• Realized gain= $11.054.60
• Unrealized gain= $41,620.00
                                                 21
              American Eagle Outfitters- Porter’s 5
                           Forces
                                             Existing loyalty to existing brands:             Low
                                             Incentives for using a particular buyer:         Moderate
                                             Barriers to entry:                               Low

                                                                      Threat of New
                                                                        Entrants
                                                                          High


                                                                    Degree of Rivalry
Buyer concentration:             Low                                     High                      Bargaining   Supplier concentration:              Moderate
Brand identity:                  High Bargaining Power       Exit barriers:         Low             Power of    Importance of volume to supplier:    Low
Consumer switching costs:        Low      of Buyers          Industry concentration:               Suppliers    Supplier switching costs:            Low
Product's importance to buyer:   Low         Low                                   Moderate           Low       Supplier profitability:              Low
Consumers are price sensitive:   Moderate                    Maturity of industry: High
                                                             Brand identity/loyalty: Low
                                                             Product differences: Low



                                                                         Threat of
                                                                        Substitutes
                                                                           High
                                             Consumer switching costs:              Low
                                             Buyer willingness to substitute:       High



                                                                                                                                                    22
    American Eagle Outfitters- SWOT
               Analysis
Strengths                                             Weaknesses
•      Significant increase in comps                  •      Inconsistent growth in historical income
•      More efficient distribution                    •     Overvalued compared to intrinsic value,
•      Strong EPS growth
                                                            P/E pricing methods
•      Increasing margins                             •     High liquidity= questionable use
•      Trading at discount to its competitors,              of financial resources
       industry
•      New, proven design team                        •     Questionable compensation of retail
•      Seen as a “cool” brand by teens                      associates



Opportunities                                         T hreats
•     New clothing line, Martin and Osa debuting      •    Unpredictable industry, subject to fashion
     fall 2006                                            trends
          --Also reaches out to new demographic       •   Higher materials prices as the result of US
•     Continued expansion into new geographic              de-facto reimposition of Multifiber Agreement
     areas including SW USA, HI, Canada,                   in summer 2005
     Puerto Rico                                      •    GAP pursuing similar strategy as Martin and
•     Slowly increasing online, international sales        Osa, possibly increased competition
                                                      •    Dependency on holiday sales, consumer
                                                           confidence. Both are in question for 2005.

                                                                                                           23
American Eagle Outfitters- Impact of
         Tariffs On Inputs




                                       24
    American Eagle Outfitters- Portfolio
             Diversification
                      DJIA                                                                                 RCMP

      Telecommunication
           Services                                                                                                             Consumer
             4%                                                                            Health Care
                                                                                                                                 Staples
                                                                                               8%
       Health Care                                                                                                                21%
                                      Industrials
           9%
                                         25%
                                                                           Consumer
  Consumer
Discretionary
                                                                         Discretionary
    13%                                                                      28%
                                              Materials
Information                                     5%
Technology                                                                        Information                                    Financials
    12%                                  Consumer Staples                         Technology                                        37%
          Energy                              13%                                     6%
            4%        Financials
                         15%
                                   Source: Adapted from Dow Jones Indexes, Component Weightings, accessed Nov. 5, 2005, available at
                                   http://www.djindexes.com/mdsidx/index.cfm?event=showComponentWeights&rptsymbol=DJI&sitemapid=20
                                                                                                                                                  25
                                   Standard and Poor’s GICS Map, effective Apr. 30, 2005, available at javascript:popup('/spf/xls/index/gics_map_April_2005.xls')
  American Eagle Outfitters- Portfolio
        Diversification (cont.)

Q) Why is RCMP’s concentration in American
   Eagle Outfitters a cause for concern?

A) Remember the GISC definition of the
   Consumer Discretionary Sector:

  The GICS Consumer Discretionary Sector
  encompasses those industries that tend to
  be the most sensitive to economic cycles.1

                 1 Standard and Poor’s GICS Industry Classification Definitions, effective Apr. 30, 2005 available at:   26
                 javascript:popup('/spf/pdf/index/GICSSectorDescriptions_April2005.pdf')
     American Eagle Outfitters-
 Questionable Employee Management
• Four American Eagle Outfitters employees
  Pennsylvania, Illinois, and New Jersey have alleged their
  former employers “violated certain federal and state
  minimum wage and related laws.” 1

• “American Eagle Outfitters, denying the allegations
  made by the employees has entered into a Settle
  Agreement for an unspecified amount.” 2

• Although it is unlikely the settlement will have any
  significant impact on earnings or stock price in the near
  future, it raises questions regarding pervasive
  improprieties within the company.
                                                                                                                                  27
                   1. Notice to Eligible Employees, Court of Common Pleas, Allegheny County, Penn., p.1, Received Nov. 9, 2005.
                   2. Id. at 1.
         American Eagle Outfitters- Relative
                 Stock Valuation

                                   ANF         GPS      PSUN      LTD       AEOS
Firm P/E                                 21.97    13.72     19.25     15.07    14.44
Industry P/E                             17.33    17.33     17.33     17.33    17.33
Firm P/E as % Industry P/E               127%      79%      111%       87%      83%

Implied Firm Growth                      6.79%      6.96%                                         5.08%              7.21%
Implied Industry Growth                  7.00%      7.00%                  7.00%                  7.00%              7.00%
Implied Firm Growth as % Implied
Industry Growth                           97%        99%                         0%                  73%              103%

Overvalued/Undervalued/
On Target                          Premium       Discount Premium                        Premium Discount



                                                                                                                     28
                                                    Data from: Yahoo! Finance, accessed Nov. 5, 2005, available at
                                                    www.finance.yahoo.com
     American Eagle Outfitters- EPS Implied
                 Stock Price


Next year's (expectected) divident payout ratio over      11.04%
(req. rate of return minus                                 8.00%
expected growth rate of dividends)                         7.21%
                                            = P/E Ratio     13.98


Stock Price
EPS times                                                   2.03
P/E Ratio (Allow for contraction from calculated above)    12.00        26.85
                             =EPS Implied Stock Price      24.41    (+ or - 10%)
                                                                        21.97



                                                                          29
   American Eagle Outfitters- Intrinsic
                Value
Assume a “reasonable” average growth rate in net
  income, say 8%

  Holding costs proportional, this generates an
  intrinsic value of $21.52. This is below the
  market price of $25.32

  Holding other factors constant, net income would
  have to grow at a rate of appox. 50% annually!

                                                  30
   American Eagle Outfitters- Review
Macroeconomic Issues
       • Relatively high energy prices
       • Questionable consumer confidence

Microeconomic Issues
       •   Firm plan anticipates launch of its new label in fall 2006
       •   Huge growth in FY 2004
       •   Questionable management relating to employee compensation
       •   Priced at discount to the market
       •   Overvalued according to EPS method
       •   Overpriced according to Intrinsic Valuation method
             – Very sensitive to changes in CAPEX spending, an area that may change
               dramatically with continued expansion, launch of new label
Other Issues
       • Portfolio diversification
             – With American Eagle constituting 20% of the RCMP market portfolio, we are
               susceptible to significant idiosyncratic risk
             – This sector is, by definition, very susceptible to cyclical nature of the economy

                                                                                                   31
       American Eagle Outfitters-
          Recommendation
  Based on the factors just listed, I feel we
   should sell 29% of our holdings, or 700
  shares of American Eagle Outfitters at the
                  market.

American Eagle is a solid firm relative to the
 industry in which it operates and I believe it
   provides good exposure to a market that
   indeed still has potential for growth. Our
  remaining 1,700 shares should provide us
                with this exposure
                                             32
 The End




Questions?


             33

				
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