AEOS, a cheap retail company

**zhao_xing** Mon Dec 19, 2005 1:32 am

AEOS, a cheap retail company
The whole article is at below link,
http://value-investing-forum.com/viewtopic.php?t=651

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 expense) last 12 months, which is equivalent to P/FCF=8.5.

I think it may not fit Blast's 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.

It repurchases shares, and Chairman bought million shares this sep.

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

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.

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.

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 behaves more like a cyclic stock. Wall street worries about this margin fluctuations.

Moreover, AE has already opened 850-900 stores in USA, and there may not be too much room for it to grow its AE brand in USA. Now, AE is going 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 safe 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 than 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 without deteriorating in fundamental, I may consider buy.

**blast_investor** Mon Dec 19, 2005 2:50 am

Why do you believe a retail stock can trade PE at 15?

Can you list a few comparative valuation to other retail stocks?
EV/EBITDA or PE whatever proper metrics.

I actually have not invested into retail apparel sector before. But I would be very eager to learn more about this sector.

By the way, Joel Greenblatt, the super value investor of hedge fund manager is recommending a similar retail stock: Gap (GPS).

**blast_investor** Mon Dec 19, 2005 2:59 am

Well, "Martin & Osa" might be the potential trouble for this stock.

AEOS "AE" business is pretty proven with its past stores. But this new concept "Martin & Osa" is not.

~ 800 stores might reach its limit already. Gap (GPS) has 3000 stores, but Gap has 3 brands as well: Gap, Old Navy, Banana Republic.

**zhao_xing** Tue Dec 20, 2005 10:24 am

Here is some comparisions among apparel Store industry (from yahoo finance):

AEOS ANF GPS PSUN
P/E 11.36 20.73 14.06 15.08
EV/EBIDTA 4.9 8.9 3.9 6.5
Oper Margins 20.73% 18.60% 11.55% 14.21%

If AE wants to get a PE 15, it needs to keep double digit or 12-15% growth rate. I think this rate is still feasible.

**zhao_xing** Tue Dec 20, 2005 10:29 am

Quote: "Martin & Osa" might be the potential trouble for this stock

Yes, I don't like transition, and I am no so certain on this new concept either. But I feeling is AE's step toward new concept is still discreet.

**zhao_xing** Tue Dec 20, 2005 10:44 am

I think the key problem is the business for this company is a little bit cyclic. Wall street worry that its margins are already on top line.

Yes, Wall Street are right at this point. But how much down cycle a retain company can go. Anyway, retail business is not a extremely cyclic business like steel or copper.

**blast_investor** Tue Dec 20, 2005 11:02 am

Growth actually is not the problem. Once the concept store works, just
reinvest money into more stores, the growth will come.

The question is whether that concept is working or not.

zhao_xing wrote:
If AE wants to get a PE 15, it needs to keep double digit or 12-15% growth rate. I think this rate is still feasible.

**blast_investor** Tue Dec 20, 2005 11:09 am

We can look at past 5 or 10 years of earning pattern to guess its cyclical nature. But my guess is that the business model does not sound that cyclical.

If US economy is completely screwed up and upper-class suffers and lose income / profit in big way, yes, this stock may be affected in very cyclically way. But that rarely happened and it is not going to happen. It probably only happened once in 1930's.

The key for this stock is probably the concept store "Martin & Osa" . If this works, then there is lots of growth ahead. If not, then this company is just throwing all the earned profit plus raised money into water, unproven.

Because company does not pay dividend, what we really get from this stock's earning is just growth of new "Martin & Osa" stores.

zhao_xing wrote: I think the key problem is the business for this company is a little bit cyclic. Wall street worry that its margins are already on top line.
.

**zhao_xing** Tue Dec 20, 2005 11:17 am

It does pay some dividend, $0.3 annually (1.5% yield). Not very high, but I think that's a typical rate for retail companies.

**blast_investor** Wed Dec 21, 2005 10:41 am

Martin & Osa concept store will start business in middle of 2006.

So the market will have uncertainty until then

**ghg777** Sun Jan 08, 2006 11:37 pm

A Blog Post on AEOS and Some Links Related to AEOS
I think AEOS is cheap at these prices. I've read similar sentiments from other value bloggers. If you're interested, my site has two posts related to AEOS.

A real short one where I just mention my interest in the stock:

http://www.gannononinvesting.com/2005/12/on_american_eagle_1.html

And a listing on my companies page that includes some links to what others have written on AEOS:

http://www.gannononinvesting.com/companies/2005/12/american_eagle_outfitters.html

I hope these links are useful. GAP and PSUN may also be stocks worth watching. They are at or approaching value territory.