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American EagleAmerican EagleOutfitters, Inc.Outfitters, Inc.

AEOSAEOS

By, Matthew McDonnellPresented 11-15-2005

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Outline

• Today, I will be discussing American Eagle Outfitters, Inc. (AEOS), which is currently a major part of our client’s portfolio.

• In addition to evaluating the firm itself, I will briefly compare American Eagle Outfitters to some of its major competitors.

• Third, I will discuss several stock valuation methods, as well as other issues facing the firm.

• Finally, I will give a recommendation regarding what should be done, if anything, regarding our holdings in American Eagle Outfitters.

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Macroeconomic Review

• Currently middle of earnings seasons• Energy prices, although falling, still at relatively

high levels• Rising interest rates affecting markets• Energy-driven inflation, questionable consumer

confidence• Many retailers reported slow start to 05 holiday

season, sales now growing stronger

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American Eagle Outfitters- Vision

• “We will be a highly profitable, international, multi-channel retail organization”

• “We will grow through a portfolio of our own distinct and segmented casual lifestyle apparel brands”

Source: American Eagle Outfitters- Latest Wall Street Presentation, Oct. 27, 2005. available at http://library.corporate-ir.net/library/81/812/81256/items/169479/Latestwebsitepresentation.pdf

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American Eagle Outfitters- Industry Classifications

Sector: Consumer Discretionary

Industry Group: Retailing

Industry: Specialty Retail

Sub-industry: Apparel Retail

Industry: Multiline Retail

Sub-Industries: Internet Retail, Catalog Retail

Adapted from: Standard and Poor’s GICS Map, effective Apr. 30, 2005, available at javascript:popup('/spf/xls/index/gics_map_April_2005.xls')

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American Eagle Outfitters- GICS Sector Description

Consumer Discretionary Sector:

“The GICS Consumer Discretionary Sector encompasses those industries that tend to be the most sensitive to economic cycles. Its manufacturing segment includes automotive, household durable goods, textiles & apparel and leisure equipment. The services segment includes hotels, restaurants, and other leisure facilities, media production and services, and consumer retailing and services.”1

1 Standard and Poor’s GICS Industry Classification Definitions, effective Apr. 30, 2005 available at: javascript:popup('/spf/pdf/index/GICSSectorDescriptions_April2005.pdf')

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American Eagle Outfitters’ Business

• American Eagle is a “leading lifestyle retailer that markets and sells [its] own brand of relaxed, casual clothing.”

• Target audience: 15-25 year-olds• Operates 846 stores in the US & Canada• Located primarily in malls, with emphasis on “A”

center stores in especially high-traffic areas• Purchases merchandise from suppliers who

either make it themselves or buy from producers.

Source: Corporate Profile- About AE, American Eagle Homepage, accessed Nov. 07, 2005, available at: http://phx.corporate-ir.net/phoenix.zhtml?c=81256&p=irol-homeprofile

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American Eagle Outfitters- Products Sold

2003-2004 Change in Sales Composition

-3%

2%

0%

-4%

-2%

0%

2%

4%

Men's apparel &accessories

Women's apparel &accessories

Footw ear- men's andw omen's

2004 Sales Breakdown

34%

61%

5% Men's apparel &accessories

Women's apparel& accessories

Footwear- men'sand women's

2002-2003 Change in Sales Composition

-8%

5%

0%

-10%

-5%

0%

5%

10%

Men's apparel &accessories

Women'sapparel &

accessories

Footwear- men'sand women's

Source: American Eagle 2004 Annual Report

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American Eagle Outfitters- Locations By State

Source Data: American Eagle Homepage

Map from Yahoo! Travel

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American Eagle Outfitters- International Sales Base

International Sales Base- 2004

Foreign7%

U.S.93%Change In International Sales Base

2002-2003 Foreign 18.28%

U.S -1.09%-10.00%

0.00%

10.00%

20.00%

1 2

Change In International Sales Base 2003-2004

U.S -0.22%

Foreign 3.12%

-5.00%

5.00%

15.00%

1 2

Source: American Eagle 2004 Annual Report

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American Eagle Outfitters- Brand Positioning

Source: American Eagle Outfitters- Latest Wall Street Presentation, Oct. 27, 2005. available at http://library.corporate-ir.net/library/81/812/81256/items/169479/Latestwebsitepresentation.pdf

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American Eagle Outfitters- 2004 Accomplishments

• 31% increase in sales (21% comparable store sales)

• 171% increase in operating income• Nearly doubled market share in specialty

denim» 2nd most purchased brand by target market

• Increased US store base by 5%» 40% of new stores on the West coast

Source: American Eagle 2004 Annual Report

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American Eagle Outfitters- 1st Half 2005 Performance

• Significant gains in teen brand popularity– Seen as “3rd coolest brand for teens”– Second most often shopped specialty brand for denim

• Comparable store sales up 20% over 1st half 2004

• 80% growth in EPS• Slow start to holiday season, downgraded Q3

earnings, later upgraded to original projections of $0.45-$0.46 per share

Sources: American Eagle Outfitters- Latest Wall Street Presentation, Oct. 27, 2005. available at http://library.corporate-ir.net/library/81/812/81256/items/169479/Latestwebsitepresentation.pdf

American Eagle Outfitters, Form 8-K filed Sept. 20, 2005

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American Eagle Outfitters- Looking ForwardPlans for 2005 and Beyond

• Expansion– New “flagship stores in NYC, Seattle”– Expansion into Alaska, Hawaii, Canada, Puerto

Rico– Still focused on Western, Southwestern US

• Evidenced by purchase of new distribution facility in Ottawa, K.S.

• New operating system used to streamline distribution

Source: American Eagle Outfitters 2004 Annual Report

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American Eagle Outfitters- Looking Forward(cont.)

One of American Eagle’s most significant plans for the future is the recent unveiling of its new brand, Martin

and Osa• Unveiled 10/20/2005, Scheduled to debut in malls in Fall,

2006– Will operate as its own business segment separate of American

Eagle brand.• Targeted to men, women age 25-40

– This is outside AE’s traditional 18-25 market– Possibly explains move to Southwest US

• Will include “classic sportswear”– Described by "a union of everything that is right about classics,

denim, and active sportswear”– Using former Abercrombie & Fitch designers to head project

Source: American Eagle Outfitters Announces Name of New Concept: MARTIN + OSA, American Eagle Homepage, accessed Nov. 1, 2005, available at: www. http://phx.corporate-ir.net/phoenix.zhtml?c=81256&p=irol-newsArticle&ID=770357&highlight=

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American Eagle Outfitters- Financial Analysis

Items of note include:1. Increasing Liquidity

-- ↑Current Assets, ↓Non-current Assets– Possible Implications: planned expansion,

anticipation of bad season.

2. Decreasing COGS as % Net Income– Implication: Irregularities with respect to

inventory management/sales– Stainable decline? Not likely.

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American Eagle Outfitters- Stock Performance vs. S&P 500 (5yrs)

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American Eagle Outfitters- Stock Performance vs. Competitors (5yrs)

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American Eagle Outfitters’ Competitors

• The Limited

• The Gap

• Abercrombie & Fitch

• Aeropostale

• Pacific Sunwear

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American Eagle Outfitters- Comparable Performance

ANF GPS PSUN AEOS IndustryForward P/E 12.69 12.07 12.97 10.69* 9.18Profit Margin 10.40% 7.43% 6.29% 11.34% 12.83%Operating Margin 18.24% 12.25% 9.84% 19.33% 20.91%ROE 27.42% 22.46% 18.01% 29.79% 29.79%ROA 17.14% 12.93% 9.18% 22.96% 22.96%

Competitor Data: Yahoo! Finance, accessed Oct. 27, 2005, available at http://www.finance.yahoo.com

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American Eagle Outfitters- An RCMP Holding

• Bought on 3 occasions: 12/1999, 03/2000, 05/2000

• Sold 25% of holdings in 04/2005• As of Nov. 7, 2005, AEOS constituted 9% of the

portfolio’ book value and 20% of the portfolio’s market value.

• Since its initial purchase, the stock price has climbed 329%

• Realized gain= $11.054.60• Unrealized gain= $41,620.00

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American Eagle Outfitters- Porter’s 5 Forces

Existing loyalty to existing brands: LowIncentives for using a particular buyer: ModerateBarriers to entry: Low

Buyer concentration: Low Supplier concentration: ModerateBrand identity: High Importance of volume to supplier: LowConsumer switching costs: Low Supplier switching costs: LowProduct's importance to buyer: Low Supplier profitability: LowConsumers are price sensitive: Moderate

Consumer switching costs: LowBuyer willingness to substitute: High

Bargaining Power of Suppliers

Low

Threat of New Entrants

High

Threat of Substitutes

High

Bargaining Power of Buyers

Low

Degree of RivalryHigh

Exit barriers: LowIndustry concentration: ModerateMaturity of industry: HighBrand identity/loyalty: LowProduct differences: Low

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American Eagle Outfitters- SWOT Analysis

Strengths

• Significant increase in comps• More efficient distribution• Strong EPS growth• Increasing margins• Trading at discount to its competitors,

industry• New, proven design team• Seen as a “cool” brand by teens

Weaknesses

• Inconsistent growth in historical income

• Overvalued compared to intrinsic value,

P/E pricing methods• High liquidity= questionable use

of financial resources

• Questionable compensation of retail

associates

Opportunities

• New clothing line, Martin and Osa debuting

fall 2006

--Also reaches out to new demographic• Continued expansion into new geographic

areas including SW USA, HI, Canada,

Puerto Rico• Slowly increasing online, international sales

Threats

• Unpredictable industry, subject to fashion

trends• Higher materials prices as the result of US

de-facto reimposition of Multifiber Agreement

in summer 2005• GAP pursuing similar strategy as Martin and

Osa, possibly increased competition• Dependency on holiday sales, consumer

confidence. Both are in question for 2005.

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American Eagle Outfitters- Impact of Tariffs On Inputs

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American Eagle Outfitters- Portfolio Diversification

DJIA

Industrials25%

Materials5%

Consumer Staples13%

Financials15%

Energy4%

Information Technology

12%

Consumer Discretionary

13%

Telecommunication Services

4%

Health Care9%

RCMP

Consumer Staples

21%

Financials37%

Information Technology

6%

Consumer Discretionary

28%

Health Care8%

Source: Adapted from Dow Jones Indexes, Component Weightings, accessed Nov. 5, 2005, available at

http://www.djindexes.com/mdsidx/index.cfm?event=showComponentWeights&rptsymbol=DJI&sitemapid=20

Standard and Poor’s GICS Map, effective Apr. 30, 2005, available at javascript:popup('/spf/xls/index/gics_map_April_2005.xls')

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American Eagle Outfitters- Portfolio Diversification (cont.)

Q) Why is RCMP’s concentration in American Eagle Outfitters a cause for concern?

A) Remember the GISC definition of the Consumer Discretionary Sector:

The GICS Consumer Discretionary Sector encompasses those industries that tend to be the most sensitive to economic cycles.1

1 Standard and Poor’s GICS Industry Classification Definitions, effective Apr. 30, 2005 available at: javascript:popup('/spf/pdf/index/GICSSectorDescriptions_April2005.pdf')

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American Eagle Outfitters- Questionable Employee Management

• Four American Eagle Outfitters employees Pennsylvania, Illinois, and New Jersey have alleged their former employers “violated certain federal and state minimum wage and related laws.”1

• “American Eagle Outfitters, denying the allegations made by the employees has entered into a Settle Agreement for an unspecified amount.”2

• Although it is unlikely the settlement will have any significant impact on earnings or stock price in the near future, it raises questions regarding pervasive improprieties within the company.

1. Notice to Eligible Employees, Court of Common Pleas, Allegheny County, Penn., p.1, Received Nov. 9, 2005.

2. Id. at 1.

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American Eagle Outfitters- Relative Stock Valuation

ANF GPS PSUN LTD AEOSFirm P/E 21.97 13.72 19.25 15.07 14.44Industry P/E 17.33 17.33 17.33 17.33 17.33Firm P/E as % Industry P/E 127% 79% 111% 87% 83%

Implied Firm Growth 6.79% 6.96% 5.08% 7.21%Implied Industry Growth 7.00% 7.00% 7.00% 7.00% 7.00%Implied Firm Growth as % Implied Industry Growth 97% 99% 0% 73% 103%

Overvalued/Undervalued/ On Target Premium Discount Premium Premium Discount

Data from: Yahoo! Finance, accessed Nov. 5, 2005, available at www.finance.yahoo.com

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American Eagle Outfitters- EPS Implied Stock Price

Next year's (expectected) divident payout ratio over 11.04%(req. rate of return minus 8.00%expected growth rate of dividends) 7.21%

= P/E Ratio 13.98

Stock Price EPS times 2.03P/E Ratio (Allow for contraction from calculated above) 12.00 26.85

=EPS Implied Stock Price 24.41 (+ or - 10%)21.97

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American Eagle Outfitters- Intrinsic Value

Assume a “reasonable” average growth rate in net income, say 8%

Holding costs proportional, this generates an intrinsic value of $21.52. This is below the market price of $25.32

Holding other factors constant, net income would have to grow at a rate of appox. 50% annually!

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American Eagle Outfitters- Review

Macroeconomic Issues• Relatively high energy prices• Questionable consumer confidence

Microeconomic Issues• Firm plan anticipates launch of its new label in fall 2006• Huge growth in FY 2004• Questionable management relating to employee compensation • Priced at discount to the market• Overvalued according to EPS method• Overpriced according to Intrinsic Valuation method

– Very sensitive to changes in CAPEX spending, an area that may change dramatically with continued expansion, launch of new label

Other Issues• Portfolio diversification

– With American Eagle constituting 20% of the RCMP market portfolio, we are susceptible to significant idiosyncratic risk

– This sector is, by definition, very susceptible to cyclical nature of the economy

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American Eagle Outfitters- Recommendation

Based on the factors just listed, I feel we should sell 29% of our holdings, or 700

shares of American Eagle Outfitters at the market.

American Eagle is a solid firm relative to the industry in which it operates and I believe it

provides good exposure to a market that indeed still has potential for growth. Our

remaining 1,700 shares should provide us with this exposure

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The End

Questions?