American Eagle Outfitters: Bears Need a Reality Check

By Leo Sun Markets Fool.com

American Eagle Outfitters (NYSE: AEO) shed about a fourth of its market value over the past five years, due to escalating concerns about fast fashion retailers, growing e-commerce rivals, and waning mall traffic. Furthermore, the bankruptcies of Aeropostale, American Apparel, and The Limited convinced investors to shun most brick-and-mortar apparel retailers.

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That's why the market is decidedly bearish on AEO, with 17% ofits float shorted as of April 25. However, I personally believe that the sell-off is overdone, and that AEO's decline offers a compelling buying opportunity for long-term investors. Let's discuss five key reasons that AEO bears might need a reality check.

Image source: American Eagle Outfitters.

1. Solid top line growth relative to its peers

Many of AEO's rivals -- like Gap (NYSE: GPS), Ralph Lauren (NYSE: RL), and Abercrombie & Fitch (NYSE: ANF) -- are struggling to post positive positive comparable store sales growth. This is how AEO's comps growth in fiscal 2016 compares:

AEO

Gap

Ralph Lauren

A&F

Comps Growth

3%

(2%)

(7%)

(5%)

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YOY comps growth, most recent quarters. Source: Quarterly reports.

3% comps growth doesn't seem high, but it's impressive considering the tough headwinds that the industry has been facing. Unfortunately, AEO's comps rose just 0.4% during the fourth quarter, and it anticipates a "flat to a low single digit decline" in comps for the current quarter. Those numbers are disappointing, but they indicate that AEO is merely treading water for now -- instead of completely reversing course.

2. The growth of Aerie

The strongest catalyst for AEO is Aerie, its rapidly growing lingerie and activewear brand. Aerie posted 23% comps growth in fiscal 2016, compared to just 1% growth at its main American Eagle brand.

Image source: Aerie.

At the end of 2016, AEO ran 102 stand-alone Aerie stores and 88 side-by-side Aerie stores at AEO locations. That represents a very small percentage of its 1,226 stores, which includes 1,050 company-owned stores and176 licensed stores. Therefore, AEO still has plenty of room to grow this high-growth brand.

During last quarter's conference call, Aerie chief Jen Foyle outlined plans to expand the brand by opening "300 plus stores over time" and diversifying the brand into new categories like swimwear.

Moreover, Aerie's body-positive #AerieREAL campaigns, which feature non-airbrushed models with a wide variety of body types, should continue winning over customers from L Brands' industry heavyweight Victoria's Secret.

3. Room for improvement in men's apparel

AEO has generally fared better with female shoppers than male shoppers. Within AE's core brand, comps at men's apparel dropped 7% last quarter due to weak sales of tops. But comps rose 4% at women's apparel, thanks to robust demand for tops -- particularly knits, shirts, and sweaters. This means that AEO needs to turn around its weaker men's apparel business to get the core AE brand's comps growth back on track.

That's why AEO Global Brand President Chad Kessler noted during last quarter's conference call that "getting men's back on track is a significant opportunity" for the company. To accomplish that, AEO has been doing more research and trend analysis with men's apparel, and recently hired a new men's GMM to lead the turnaround effort.

Moreover, AEO's acquisition of menswear labelTodd Snyder, which owns the collegiate apparel brand Tailgate, could also evolve into another pillar of growth for the men's business -- just as Aerie became a fresh way to attract female customers.

4. Solid digital growth

AEO is primarily known as a brick-and-mortar retailer, but 27% of its revenue actually came from digital channels last quarter. This can likely be attributed to the strength of its AEO app, which offers innovative features like AEO Radio, mix and match options for Aerie, a Snap & Scan feature which matches photos of clothes with similar in-store styles, and collections organized by hashtags.

Image source: Google Play.

Like many other retailers, AEO is rebalancing its brick-and-mortar footprint while increasing its digital presence. But unlike many other retailers, which are aggressively shuttering stores, AEO actually gained three more company stores throughout 2016.

5. A low valuation and a high dividend

Last but not least, AEO's decline gives it a low valuation and a high dividend -- which should set a firm floor under the stock. AEO trades at 12 times earnings, which is much lower than its industry average of 19. AEO currently pays a forward dividend yield of 3.6%. The company hasn't raised that dividend since 2013, but its low payout ratio of 43% leaves it plenty of room for future hikes.

The key takeaway

I'm not saying that AEO will rally anytime soon. But its decent growth relative to its rivals, the standout growth of Aerie, its room for growth in men's apparel, its low multiple and high dividend all indicate that it's wiser to buy this stock than to sell it.

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Leo Sun owns shares of American Eagle Outfitters. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.