American Eagle Outfitters (AEO)

The company’s mature profile may limit growth going forward. Management is responding with the roll-out of the aerie, 77kids and Martin+Osa brands in an effort to expand their potential market. Only aerie has gained traction so far. In general, fashion trends change and “cool” brands naturally go stale despite revamp efforts.

AEO, like many other small-medium retailers, borrows its short-term revolving credit line from the ailing bank CIT, which filed for Chapter 11 bankruptcy on November 1, 2009. CIT's bankruptcy process will likely place a freeze on all lendable assets and cut off funds for its borrowers like AEO. The financing hit for the retailer also comes right before the important holiday season, during which time short-term financing is indispensable for stocking inventory and other cash needs.

• Over half of their short-term liquidity ($372M) is locked up in auction-rate securities. While management stated that cash on hand is more than enough to fund operations through the spring, the seasonal pick-up toward the back end of the year could strain resources.
• The company disclosed opening and drawing down a $75M credit facility subsequent to FY 2008, meaning the company is not debt-free, as is often asserted when browsing internet research on the stock.
• Balance sheet lacks “hard” assets:
  • About one-third of their $1.9B in assets is investments.
  • Over 80% of property, plant & equipment (PPE) consists of leasehold improvements and fixtures. My estimate is ~$535M of PPE ($626M) as of the 2007 10K filing falls into this category.
  • While there is no doubt that these improvements provide value for the company as an ongoing-concern, they provide little backstop when valuing the company on a non-ongoing basis.
  • For example, if business were to deteriorate considerably, it is doubtful that the company would be able to monetize its capitalized leasehold improvement assets to raise cash. In fact, it may even have to

write down unplanned store closings.

• American Eagle is committed to an aggressive capex program ($250 - $275M) even as their business trends are declining markedly.

Retailers such as Buckle, Inc. and Aeropostale have shown that teenagers will still spend money on clothes even during a recession--they often do not have as many financial obligations as their parents have, meaning they can spend more freely. Therefore, AEO's slumping sales have less to do with the recession than with their product offering, which is not appealing enough to get its fickle core demographic into its stores. American Eagle needs to focus on what will make it a trendy brand once again or its poor sales will only continue.