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American Eagle (NYSE: AEO) is a mall-based apparel and accessories retailer that sells its own brands of products throughout the U.S. and Canada. AEO operates three different chains (American Eagle Outfitters, aerie, and Martin + OSA), each of which targets a different segment of customers within the broad 15-40 age group.^[1] While the company maintains three separate brands, the overwhelming majority of AEO's sales come from its namesake American Eagle operations. In fiscal 2008, AEO generated $3 billion^[2] of sales with a 10.1% operating margin^[2], placing it second in the youth apparel retail sub-market in terms of operating profit and revenue behind high-end competitor Abercrombie & Fitch Company (ANF).

AEO has branched out from its 15 to 27 year old customer segment in order to diversify and enhance the company's scope and scale. During 2006, AEO launched its sub-brands aerie (lingerie) and Martin + OSA (sportswear) to target a broader customer base.^[3] In order to enter new markets, the company has also entered into a partnership with an international retail operator to open stores in the Middle East. This decision has the added benefit of reducing the effects of U.S. economic cycles on the company's bottom line. The recession in the American economy led to decreased sales in two of the company's most important seasons: back to school and holiday.

Business Overview

An American Eagle Outfitters storefront in a mall

American Eagle sells its own brands of clothing and accessories in mall-based retail stores in the U.S. and Canada.

2008 saw a decrease in revenue, same store sales and operating margin. The recession in the American economy resulted in decreased consumer spending. In an effort to encourage its customers to buy more goods, American Eagle increased the number of sales and promotions it made, which led to a 17% decrease in gross profit.^[4] Comparable store sales showed little change in menswear but declined in the high teens in women's clothes and accessories. Average transaction value remained flat despite the fact there was a mid-single digit decline in average unit price. This was due to the fact the average number of transactions per customer increased as consumers took advantage of lower prices and bought more goods.^[4]

American Eagle has seen some improvement in the first quarter of fiscal 2009 (ended 5/2/09). Comparable store sales for women's apparel decreased 13% instead of the previous quarter's 23% decline.^[5] Comp store sales for aeris and MARTIN + OSA increased by 17 and 7% respectively.^[5] The company has also signed a franchise agreement with M.H. Alshaya, an international retail operator. Alshaya will open American Eagle Outfitter stores in the Middle East, with the first one set to open in early 2010. The franchise will require no capital investment from AEO and will be operated primarily by Alshaya, however the deal promises substantial revenues for the company, which is attempting to target young, wealthy consumers in that region.^[5]

2008 Sales by Geographic Region

Trends and Forces

Expanding aerie and Martin + OSA

One of the lynchpins to AEO's growth plans is to grow its aerie and Martin + OSA store brands. aerie offers intimate apparel (underwear, bras, pajamas, robes, etc.) to 15 to 25 year old women, whereas Martin + OSA sells denim and sportswear designed for 25 to 40 year old men and women.^[7] At the end of fiscal 2006, AEO operated only 3 stand-alone aerie stores and 5 Martin + OSA stores and neither segment had generated a significant amount of revenue (the company did not break sales out).^[8] At the end of fiscal 2008 the company operated 116 aerie and 28 MARTIN + OSA stores.^[9] The rapid growth of these retail concepts reflects the positive effect they've had on the company's balance sheet. In the first quarter of fiscal 2009 aerie had a 17% increase in comp store sales and MARTIN + OSA saw a 7% increase in sales. It is interesting to note that, though both chains pursue the same demographic, Abercrombie & Fitch's RUEHL line is set to close in 2009, whereas MARTIN + OSA will expand.

American Eagle's Main Sales Seasons Impacted by Recession

Because the overwhelming majority of the customers of AEO's brands age from 15 to 25 years old and are students at some level of education, AEO traditionally experiences a significant boost in sales during the end of summer as students shop in preparation for school. The back-to-school shopping season also boosts sales for AEO's competitors such as Abercrombie & Fitch, Aeropostale (ARO) and Pacific Sunwear of California (PSUN). In addition, the retail industry typically sees a large boost in sales leading up to the holidays in November and December. However, in 2008 the American economy slipped into a recession, which made consumers across all income levels less certain of their financial security. They responded to the increasing economic uncertainty by cutting back on non-discretionary spending. Both the back-to-school and holiday seasons of 2008 have been marked by decreased sales and earnings per share.

• Back-to-School: Most of AEO's back-to-school sales are included in the third fiscal quarter (ends in early November). During the 3rd quarter of fiscal 2008, earnings per share dropped 33%^[10] and comp store sales decreased by 7% compared to a 2% increase during the same period in 2007.^[10] Plus, gross margin decreased 6.4% from the same period in 2007.^[10]

• Holiday Season: The holiday season occurs during November and December and is part of the fourth quarter of American Eagle's fiscal year. During the 2008 holiday season same store sales declined by 16%%^[11] and earnings per share decreased 71%.^[11] Although the company tried to encourage more purchases through the use of promotions, those promotions (such as buy-one-get one 50% off) lowered the company's margins, leading to the 71% decrease in earnings.

American Eagle Beginning to Spread Out its Stores

Before the deal with M.H. Alshaya, American Eagle stores were located only in the United States and Canada. This lack of international diversification leaves the company at the mercy of U.S. economic cycles, meaning a slowdown in spending in the United States will not be offset by sales from another region. Decreasing exposure to the economic cycles of one particular region makes a company more able to withstand recessions and other negative events in those regions. Though a number of clothing retailers have flocked to Asia in order to take advantage of developing wealth there, American Eagle has instead made an agreement to open stores in the Middle East, another wealthy region. By spreading its stores across a wider area, the company opens itself to new markets and new sources of revenue.

Competition

AEO competes with several other retailers in the 14-30 year old apparel market. AEO has consistently been at the top of its sector in terms of profitability and is one of the largest companies in the market in terms of net sales. AEO's 21.0%^[2] operating margin is the highest out of all of its competitors, even considering that its 48.0% gross margin rate is considerably lower than the 66.6% gross margin rate of AEO's main competitor, Abercrombie & Fitch Company (ANF).

American Eagle's competitors include:

• Abercrombie & Fitch Company (ANF): Abercrombie & Fitch is one of AEO's main rivals. ANF is a larger company than AEO, with a greater store base and higher net sales than AEO. Abercrombie & Fitch Company (ANF) also operates four brands: Abercrombie & Fitch, Hollister, abercrombie, and RUEHL; all of which target different subsets of the 8-30 age range. While AEO's namesake stores compete directly with A&F and Hollister stores, and AEO's new Martin + OSA concept competes with ANF's RUEHL, AEO has no match for A&F's kids apparel concept: abercrombie. Although ANF is one of AEO's most direct competitors, the two company's operate with different strategies: Abercrombie maintains a premium brand with high price points while American Eagle attempts to reach a larger range of customers with relatively lower price points on trendy products. Abercrombie & Fitch is planning on closing all RUEHL stores by January 2010.
• Aeropostale (ARO): Aeropostale is a smaller company than AEO, with the overwhelming majority of revenue coming from only its namesake brand of stores that targets 14 to 17 year olds. Aeropostale's business model also relies heavily on sales and promotions, something that AEO is trying to move away from in order to keep margins high. Aeropostale (ARO) and AEO compete for the same set of customers, ARO's sales increased 18.5% from 2007 to 2008, a stark contrast to competitors American Eagle and Abercrombie & Fitch, which both reported decreases.

References

1. ↑ AEO 2008 Annual Report pg. 1  
2. ↑ ^{2.0 2.1 2.2 2.3 2.4} AEO 2008 Annual Report pg. 17  
3. ↑ American Eagle Outfitters (AEO) Annual Report 2006, "Chairman's Letter", p.5-6
4. ↑ ^{4.0 4.1} AEO 2008 Annual Report pg. 22  
5. ↑ ^{5.0 5.1 5.2} American Eagle Outfitters F1Q09 (Qtr End 5/2/09) Earnings Call Transcript.
6. ↑ AEO 2008 Annual Report pg. 3  
7. ↑ American Eagle Outfitters (AEO) Annual Report 2006, "Chairman's Letter", p. 5-6
8. ↑ American Eagle Outfitters (AEO) 10-K 2006, "Growth Strategy", p. 5
9. ↑ AEO 2008 Annual Report pg. 23  
10. ↑ ^{10.0 10.1 10.2} American Eagle Outfitters, Inc. F3Q08 (Qtr End 11/1/08) Earnings Call Transcript.
11. ↑ ^{11.0 11.1} American Eagle Outfitters, Inc. F4Q08 (Qtr End 01/31/09) Earnings Call Transcript.
12. ↑ ANF 2008 Annual Report pg. 23  
13. ↑ ARO 2008 Annual Report pg. 19