Increased Online Sales Boost Top Line But Pressure The Bottom Line For American Eagle

American Eagle Outfitters  ( AEO ) bucked the declining retail trend in its second quarter, posting an increase of 2.7% in its revenues, and comparable sales growth of 2%. The retailer managed to beat consensus expectations on both revenue and EPS, coming in at $21 million above revenue estimates, and 3 cents higher than predicted for earnings per share. However, while the latter is down considerably year-on-year, the news of the beat brought a cheer, with the stock of the company rallying in the wake of the earnings announcement. However, this rise in the share price should be taken with a pinch of salt, as AEO is only recovering the losses it has seen in its stock price in the past two weeks. That being said, it was still a solid quarter, better than the performance seen for a number of apparel retailers, with AEO delivering a tenth consecutive quarter of comps improvement. The Aerie brand was again the driver for much of the growth seen in the company, and the work undertaken by the management places AEO in a better position than most in this blighted sector to deliver sustained growth.

E-Commerce Business Remains A Standout

American Eagle delivered a tenth straight quarter of double-digit gains in its online sales, which represents 23% of the total revenue. This strong growth was driven by higher traffic and better conversion. Given the robust performance of this business, the company has focused its marketing on the digital space, which has been highly effective in drawing in new customers. To reel in these customers, AEO is also launching a new rewards program soon, which should ensure growth in the future as well. AE jeans, which registered an impressive performance this time around as well, will also be included in the rewards program. The jeans also represent another avenue for long term success, with the company growing to be the number two retailer in America across all demographics. Furthermore, since less than 40% of the transactions in the back-to-school time period included jeans, it reflects a potential upside.

The Aerie brand also continued its tremendous growth, achieving 26% comps growth, building on the 24% seen in the prior year quarter. This figure is all the more impressive when compared to the growth figures delivered by its competitors. While the brand is much smaller in terms of sales when contrasted with Victoria’s Secret, the latter posted a comps decline of 14% this quarter. New product lines of Aerie carried on the success of the lingerie business, with the swimwear, including Chill.Play.Move, delivering growth that exceeded expectations. The successful marketing campaigns run by the brand resonate well with the consumers, making it poised to carry on its growth in the future. This segment of the company has also benefited from the immense growth of the online business, which represents 40% of the sales posted by Aerie.

Excessive Promotions Pressure Margins

While the top line growth delivered has been impressive, given the soft sate of the apparel retail market in the country, it may have been driven by the promotions put in place by AEO. This factor has strained the margins, with a 260 basis points decline witnessed in the gross margins. A slower start to the quarter, and unfavorable weather conditions have been blamed for the rise in promotions. However, the sales trends were better than the first quarter, with positive traffic, more transactions, and a higher average unit retail price in the second quarter. A greater focus on the online space, reflected by a higher digital marketing spending, pushed up the SGA expenses, which coupled with the higher promotions, were responsible for the 370 basis points fall in the operating margin.

As the company aims to maximize the omnichannel business, it continues to evaluate its store fleet. Over the past two years, AEO has renegotiated over 350 lease renewals, securing an 8% reduction in the cash rents. As of now, nearly half (530 leases) will expire over the next three years, giving the company the flexibility to implement its store closure plans. However, the company did say that its stores remain profitable, and are a driver for customer acquisition for the digital channel, with 70% of Aerie’s online sales coming in areas where it had a retail presence.

Looking ahead, the company expects a third quarter earnings of $0.36 to $0.38 per share, based on comps growth of flat to low-single digits. This reflects a fall from the $0.41 seen last year. Higher promotions are set to continue in the quarter, along with an increase in the SGA expenses, which will again pressure the margins, though the decline may improve sequentially. However, as the company expands, it will be able to get better costing, which will ease the margins a bit in the future.

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