AEOS

**zhao_xing** Sat Dec 17, 2005 7:18 pm

AEOS
Hi blast,
How about American Eagle Outfitters Inc. (AEOS)?

This stock declined since this summer due to market's worry about its operating margin and unexciting same store sale.

Now, it drops to around 21, with PE=11.5 ROE=31%. By my calculation, it generated around $360million free cash flow( cash flow from operation - capital expenture) last 12 months, which is equilavent to P/FCF=8.5.

I think it may not fit your standard as a dirty cheap stock, but it still relatively cheap as a retail stock. At least, I think it can keep double digit growth (in next 3-5 years) and deserve a PE 15.

Thanks!

**zhao_xing** Sat Dec 17, 2005 7:21 pm

By the way, It repurchases shares, and Chairman bought 1million shares this sep.

**zhao_xing** Sat Dec 17, 2005 7:27 pm

No debt, and around $680 million in cash and cash equivalent (short/long-term bonds)

**blast_investor** Sat Dec 17, 2005 10:50 pm

American Eagle Outfitters - AEOS is very interesting.

How do you feel about its business model going forward?

**zhao_xing** Sat Dec 17, 2005 11:09 pm

I think its business model is generally stable. The brand is well recognized. It had bad years in 2002, 2003, and the earning jumped in 2004.

The profit growth rate is 18% for past 5 years, and 31% for past 10 years (from value line),

I think this company may still had some tough days to go for its recent soft sale, but generally it is not too hard for a retail company to keep what it already could earned. (EPS 1.8 )

I believe, one day this company could eventually be priced at PE 15 (or even 18 ). At that time, stock price will jump to around 30. I think this time frame may be in 1-2 years.

**zhao_xing** Sat Dec 17, 2005 11:19 pm

As peter lynch said, " as long as same store sale can grow, it is usually paid to keep holding a retail stock"

I think for its PE 11.5, even 1~2% same store sale growth rate is ok for me.

**blast_investor** Sat Dec 17, 2005 11:23 pm

Yes, retail stocks have one of the best business model there. Once it works in one part of USA, it can easily duplicate into other states.

I wonder why AEOS dropped big from high of $34 to $21 now. Was there any reason behind this?

**zhao_xing** Sat Dec 17, 2005 11:25 pm

Actually, I don't know. I need to try to dig out more information.

**blast_investor** Sun Dec 18, 2005 11:02 pm

It looks like the recent price drop is due to sale's forecast disappointment:

http://yahoo.reuters.com/financeQuoteCompanyNewsArticle.jhtml?duid=mtfh54120_2005-11-30_23-07-38_n30383583_newsml

**zhao_xing** Mon Dec 19, 2005 1:19 am

This company's customers are oriented toward 15-25 young men from high income families. It sells its clothes more expensive than its peers by promoting its brand.

Historically, the operating margin of AE swing more than its peers, and its stock price bevahes more like a cyclic stock. Wall stree worries about this margin fluctations.

Moreover, AE has already opened 850-900 stores in USA, and there may not be too much room for it to grwo its AE brand in USA. Now, AE is goting to make a transition and launch a new concept "Martin & Osa" store from next year. However, transition means uncertainty, and Wall street hates uncertainty.

To be honest, I am not so optimistic about the stock price for next 3-6 months. I also acknowledge that AE's future growth is limited and transition is uncertain.

However, my feeling is that this stock is still a save pick. Balance sheet is clean, which means management didn't waste their money to do bad-diversification. Also, they make quite discreet step toward advocating "Martin & Osa" concept. ( They plan to open 10-15 M&O store next year. If the concept succeeds, they will open 25-30 stores per year then)

Anyway, retail is still a retail. The worst case is that earning keeps flat or drops a little. It's very unlikely the earning will lost more thant 20%-30%. I believe limited growth future and uncertainty has already been priced in. Even if the stock price drops
down more, I still can average down the cost in this case. I believe it has a (top) strong brand name so that everything will come back eventually. One day, eventually it has chance to be priced at PE 15, and my current target price is 27~28.

The key point is what's time frame we need to wait, on which I am not so certain. Due to this points, I think this stock is not as good as Blast's picks. If stock price drops a little bit further withought deteriorating in fundamental, I may consider buy.

**zhao_xing** Tue Dec 20, 2005 11:11 am

Hi blast,
I found below text on AE's 2004 annul report.

"
Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of

American Eagle Outfitters, Inc.

We have audited management’s assessment, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting, that American Eagle Outfitters, Inc. did not maintain effective internal control over financial reporting as of January 29, 2005, because of the effect of the Company’s ineffective controls over the selection and monitoring of appropriate assumptions and factors affecting the accounting for leases and tenant allowances, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO control criteria). American Eagle Outfitters, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management’s assessment: In its assessment as of January 29, 2005, management identified as a material weakness the Company’s ineffective controls over the selection and monitoring of appropriate assumptions and factors affecting the accounting for leases and tenant allowances. As a result of this material weakness in internal control, American Eagle Outfitters, Inc. concluded the Company’s previously reported fixed assets and deferred lease credits had been understated and that previously issued annual and interim financial statements should be restated. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the fiscal 2004 financial statements, and this report does not affect our report dated April 8, 2005 on those financial statements.

In our opinion, management’s assessment that American Eagle Outfitters, Inc. did not maintain effective internal control over financial reporting as of January 29, 2005 is fairly stated, in all material respects, based on the COSO control criteria. Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, American Eagle Outfitters, Inc. has not maintained effective internal control over financial reporting as of January 29, 2005, based on the COSO control criteria.

Ernst & Young LLP

Pittsburgh, Pennsylvania

April 8, 2005

"

Usually, weakness in internal control means some problem in accounting, and stock price will suffer from that. (eg. OCA, UTSI)

I think AEOS is still much different from UTSI.
(1) UTSI relies heavily on single declining product; AEOS 's business is generally stable.
(2) From the view of cash flow, UTSi didn't make too much money even at its golden time, it waste too much money to acquire small non/little profitable companies; AEOS invests on bonds, which is much more conservative.

So, how do you evaluate the internal control weakness in AEOS, and in generally case?

Thanks!

**blast_investor** Tue Dec 20, 2005 11:18 am

I am not very concerned with internal control issue with this stock AEOS as long as the price is cheap. AEOS insiders are still buying it big way.

But the growth of this company is my concern. or the "investment" portion is still not clear.

If the growth is questionable, then the whole valuation changes, we can not assume the same "return on asset" growth any more.

There is not much information there too. It would be best if someone can visit the new concept store and get assessment of business there.