ANF Abercrombie and Fitch Co

American Eagle Outfitters Inc.’s (AEO) recently reported third-quarter 2011 earnings of 27 cents per share that came in line with the Zacks Consensus Estimate. However, it was lower than the previous-period earnings of 29 cents per share primarily due to higher cotton costs and markdowns, partially offset by higher revenue growth resulting from holiday season.

Quarterly Review

During the quarter, American Eagle’s net sales went up 10.7% year over year to $831.8 million, beating the Zacks Consensus Estimate of $821 million. Growth in revenue was driven by a 5% increase in comparable store sales primarily during the Thanksgiving weekend. During the period, the company’s AE Brand, aerie and AEO Direct segments reported a growth of 5%, 8% and 21%, respectively, in comparable store sales.

Higher cotton costs and markdowns attributed to a decline of 1.1% in gross profit during the quarter, while gross margin contracted 450 basis points to 37.1%. However, the negative factors were partially offset by a positive impact from lower occupancy and warehousing expenses as a percentage of net sales.

Consequently, operating income declined 9% to $83.2 million from $91.5 million in the prior-year period. The decline in operating income was also impacted by an increase in Selling, General and Administrative expenses.

Financial Position

American Eagle ended the quarter with cash and cash equivalents of $380.3 million compared with $630.8 million in the year-ago period. For the nine months period of fiscal 2011, cash used for operating activities came in at $48.1 million.

During third-quarter 2011, the company deployed $31 million towards capital expenditure, out of which approximately $22 million were expended on opening of new stores and remodeling of old ones.

Year-to-date, the company deployed $96.7 million toward capital expenditures and is expecting to incur a total of $100 million in fiscal 2011, revised from its previous guidance range of $90 million to $100 million.

Guidance

The company believes that the momentum of strong sales during the holiday season will continue. However, pressure on margins is also expected due to rising cotton costs. Therefore, American Eagle anticipates to earn in the range of 40 cents to 44 cents during the fourth quarter of fiscal 2011. The current Zacks Consensus Estimate for fourth-quarter 2011 is 41 cents per share.

Store

In the reported quarter, the company opened 6 AE and 7 aerie stores, while remodeled 5 stores. Currently, the company operates 937 American Eagle stores, 158 standalone aerie stores and 21, 77kids stores, across the United States and Canada. The company sells its merchandises via its e-commerce in 77 countries.

Conclusion

We remain impressed with the company’s continued momentum in denim along with improved merchandise assortments in the women’s business segment, which will likely lead to a turnaround in its top line as well as a rebound in gross margin.

The company operates in a highly fragmented specialty retail sector and faces intense competition from other teenage-focused retailers, such as Abercrombie & Fitch Co. (ANF) and Gap Inc. (GPS).

We currently have a short-term Zacks #2 Rank (Buy) and a long-term Neutral recommendation on the stock.

 
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