American Eagle Outfitters, Inc. (NYSE:AEO) is a stock we have traded, most recently getting behind it for a buy in June at $10 a share. The stock had essentially doubled from that call, but is giving a massive chunk of that back today, with shares down 17% as we write.
One could argue that the trade was mean reversion, and it was one reason we saw shares as a buy in June, and the action had been incredibly positive at a time where retailers have been struggling. So, some of this definitely some giveback of those gains. Ultimately, we think shares could decline back to the $15 range, where we would view shares as a buy once again. For now, we rate AEO a hold, as many of our followers are likely running a house position with their significant trading gains. Make no mistake, the stock was teetering, looking to head into the single-digits, but caught a bid through the summer and into early fall.
Here is the deal. The fact is that the just-reported Q3 earnings were quite good, but following our buy the follow-through in AEO shares had been impressive, perhaps running too far too fast. While the quarter was good, and there was a guidance raise, it was not a stellar quarter, so we surmise the Street was looking for more. So, let the action take the stock back down, then consider some buying if you do not own any specialty retail. We saw similar positive action in other similar names like Gap (GPS) and Abercrombie (ANF), but the valuation here is still relatively attractive, especially on this big pullback. The holiday quarter outlook looks solid even considering the macroeconomic weakness and challenges the consumer is facing.
In terms of the quarter, the number one thing to watch is comparable sales. They are so key for retailers. Well, sales for Q3 were a company record. Net revenues were $1.3 billion, up 5% compared to last year. Aerie brand revenue of $393 million rose 12%, with comparable sales up a whopping 12%. American Eagle revenue was $857 million and rose 2%, while comparable sales increased 2%. We love to see increasing comps.
One of the reasons the stock had been bid up so much was not just anticipated sales improvement, but the fact that margins were set to improve. Folks, this was a good quarter, just not “enough” in our estimation. Gross profit was $544 million and was up about 13%. Gross margin was a strong 41.8%, up 310 basis points from a year ago driven largely by strong consumer demand despite macro pressures. Further, inflation subsided some leading to lower product and freight costs. And the company had put into place a cost savings program to boost profit including lower markdowns and employing leverage on rent, distribution and warehousing and delivery.
One negative was that selling and administrative expense was up 16% to $362 million, though this was in line with their prior guidance. Store payrolls also increased largely due to higher wages. Labor inflation persists, though the pace of it is abating.
Putting it all together, we saw operating income of $125 million, good for a respectable 9.6% operating margin. The operating income was the second highest for the company since 2012. Net income was $96.7 million, or $0.49 per share, up from $0.42 per share a year ago.
Should shares be getting this hard? It may be an overreaction frankly. The outlook was a guidance raise, though we still contend the Street must have been looking for more. But momentum is continuing into the holiday quarter. In the press release, Jay Schottenstein, AEO’s Executive Chairman of the Board of Directors and Chief Executive Officer stated:
“Momentum has continued across the business into the fourth quarter, driven by strong holiday assortments, engaging marketing campaigns and solid execution, supporting our improved outlook for the rest of the year. Looking ahead, we remain focused on advancing our long-term strategic priorities, as we seek to create consistent growth across our portfolio of brands and generate efficiencies for improved profit flow-through. We are set up to deliver on both in 2024.”
Folks this is pretty bullish. Let shares settle out, then do some more buying. While you may have missed the early gains, there are more to be had. Risks do include a mild recession in the future, pressure on the consumer, and student loan repayments cutting into discretionary budgets, but the company has successfully navigated this to boost profit and lower markdowns, while effectively bringing in sales in a competitive landscape. The company ended the quarter with cash and cash equivalents of $0.24 billion, and no long-term net debt. That is positive. Inventory was down, another positive. Total ending inventory declined 4% to $769 million, with units down 3%.
And as we alluded to, the company raised guidance. For fiscal 2023, management expects revenue to be up mid-single digits to last year, compared to prior guidance for revenue up low single digits. The raised the operating income outlook to bringing that up to an expected $340 to $350 million, at the high end of prior guidance of $325 to $350 million. This comes on the back of a view that revenue in Q4 will be up high-single digits and operating income will be in the range of $105 to $115 million.
American Eagle Outfitters, Inc. has done nothing wrong. Our take is that the stock rose too far too fast, so we are seeing some back reversion, and that perhaps the Street was looking for even more. All things considered, if you were with us for the big early gains, then you are running a house position now, having sold your initial investment plus some profit when shares were up 50%-75%. New money can consider coming in on the selloff around $15-16.
Read the full article here