American Eagle Outfitters
(AEOS)
Dan DeRose
Matthew McDonnell
14-November-2006
Presentation Outline
•
•
•
•
Company overview
RCMP Position
Macroeconomic/Market overview
Industry overview
– Porter’s 5 forces
•
•
•
•
Firm strategy/development
Stock performance
Portfolio “fit”
Firm financial performance
– Historical cycles and margin analysis
– Relative ratio analysis
– DuPont Decomposition
•
Valuation
– Margin, ratio & multiple analysis
– Discounted cash flow (DCF)
•
Recommendation
Part 1: Company overview
American Eagle Outfitters- The
Business
• Business: Specialty clothing retail
• Product: Casual clothing (tops, bottoms), intimates,
footwear, outerwear, accessories, and fragrances
• Target customers:
– AEOS= 15-25yrs
– Martin + Osa= 25-40
• Venues: Primarily mall-based stores with limited standalone stores and internet sales
• Geography:
– Stores in all 50 states, Puerto Rico, and Canada
– Limited online sales to locations outside USA
Company Overview
•
1994:
– Incorporated as Natco Industries Inc.
•
1999:
–
•
Adopts present name
2000:
–
Bought 3 Canadian businesses
• Thriftys/Bluenotes, Braemar, National Logistic Services
• 3-2 Stock spit
•
2004:
– Thriftys/Bluenotes sold
– 2-1 Stock split
– First ever dividends paid
•
2005:
– Announces launch of Martin + Osa, Arie
– Dividends raised
•
2006:
–
Much of National Logistic Services
Part 2: RCMP Position
RCMP Position
• Transaction history
– 10-Dec-1999:
• BOT 200 shares at $44.00
– 10-Jan-2000:
• BOT 200 shares at $27.00
– 3-May-2000:
• BOT 600 shares at $15.63
– 23-Feb-2001:
• 3-2 split
– 8-Mar-2005:
• 2-1 split
– 25-Apr-2005
• SLD 600 shares at $26.28
– 16-Nov-2005
• SLD 700 shares at $23.33
RCMP Position
• Gains/losses
–
–
–
–
Book value of holdings= $13,504
Realized capital gains= $21,842
Unrealized capital gains= $ 65,454
Market value of holdings= $ 78,778
• Portion of portfolio MV= 22.70%
SRZ
5%
SRCL
4%
AEE
WAG
6%
AEOS
AEE
6%
CPRT
M VSN
2%
AEOS
22%
MS
9%
FR
JKHY
JPM
KMB
KM B
6%
CPRT
9%
JPM
13%
JKHY
5%
FR
13%
MS
MVSN
SRCL
SRZ
Part 3: Macroeconomic and Market
Overview
Macroeconomic/Market Overview
• Macroeconomic
overview
– Economic growth in
Q2, Q3 2006 lower
versus previous year
Macroeconomic/Market
Overview
• Consumption
spending
– Weak y/y summer
– Strong y/y fall
Macroeconomic/Market
Overview
• Clothing and shoe spending steady since 2003
• 2006 Q1, Q3 stronger y/y, 2006 Q2
significantly weaker
Real Annualized Change in Expendatures 2003-2006 Q3
0.40
0.20
0.10
Clothing and Shoes
-0.20
2006:Q3
2006:Q1
2005:Q3
2005:Q1
2004:Q3
2004:Q1
2003:Q3
2003:Q1
-0.10
2005
0.00
2003
% Change
0.30
Macroeconomic/Market
Overview
• Clothing and shoe spending very non-cyclical
– Although we do not have data for specialty clothing
retailers such as AEOS, we would likely expect much
more sensitivity to changes in real GDP growth
Annualized Rates of Change 2003-2006 Q3: Real GDP and Clothing
and shoes
8.00
7.00
6.00
5.00
4.00
Clothing and shoes
3.00
Real GDP
2.00
1.00
20
03
20
04
20
20 05
02
20 :Q
03 4
20 :Q1
03
20 :Q2
03
20 :Q3
03
20 :Q4
04
20 :Q1
04
20 :Q
04 2
20 :Q3
04
20 :Q4
05
20 :Q1
05
20 :Q2
05
20 :Q
05 3
20 :Q4
06
20 :Q1
06
20 :Q2
06
:Q
3
0.00
-1.00
Part 4: Industry Overview
Industry Overview- Specialty
Clothing Retailers
Threat of new
entrants
HIGH
Power of
Customers
MODERATE
Power of Suppliers
LOW
Overall Threat
Level:
High
Industry Rivalry
HIGH
Threat of
Substitutes
LOW
Part 5: Firm Strategy and
Development
Firm strategy/development
• Open 45-50 stores per year
• Remodel and/or relocate 45-50 stores per year
until all 160 stores in old format are updated
– Renovated stores achieved an annual sales increase
of 46% on a 29% increase in square footage
• Sustain momentum and position brand
– Jeans became number one specialty store brand
purchased – doubling market share since 2003
– Focus on knit business such as polo's, graphic Ts and
tank tops
Firm strategy/development
• Product Mix
– Product mix has remained constant last several years with slight
shifts toward women’s apparel and accessories at the expense of
men’s apparel and accessories
AEOS Product Sales Mix 2000-2005
100%
8%
7%
5%
5%
5%
5%
80%
60%
52%
54%
57%
60%
61%
60%
Women's apparel and
accessories
40%
20%
Footw ear- men's and
w omen's
40%
39%
38%
35%
34%
35%
2000
2001
2002
2003
2004
2005
0%
Men's apparel and
accessories
Firm strategy and development
• Continue to develop aerie
– Sub-brand of intimates (bras,
panties, dormwear, and personal
care) that is consistent with the
AE lifestyle
– Real estate strategy consists of
integrated, side-by-side, and
stand-alone stores
Firm strategy and development
• Develop Martin + Osa
– New brand aimed at designing sportswear for
the 25-40 year old customer
– Opened 4 stores in August, plan on opening 1015 in 2007
Firm strategy and development
• Expanding distribution centers in Kansas
to support further growth of AE and Martin
+ Osa
Firm strategy and development
• Recently, the firm has stressed expansion
into the Southwest US
2000
2002
2004
2005
Part 6: Stock Performance
Stock Performance
•
•
•
•
Current Price : 47.50
52 Week Range: 19.45 – 47.48
Stock price up 203% since January 3rd
Dividends
– Quarterly dividend increased to $0.113 from
$0.075 in 2nd quarter
Stock Performance
• AEOS has
outperformed S&P
and NASDAQ for 5 yr.
and 6 mo. intervals
Stock Performance
• AEOS has outperformed
competitors ANN, ANF,
and LTD for 5 yr. and 6
mo. intervals
Part 7: Portfolio Fit
Portfolio Fit- Diversification
•
•
•
Holdings as % of Total Book Value
AEOS, our
largest holding,
comprises 22% of
market value of
portfolio
(November 7th)
As shown in the
graphs on the
right, this
concentration is
due to high
relative AEOS
appreciation
Our next largest
holdings are JPM
and FR at 13%
each
AEE
AEOS
WAG
6%
SRZ
12%
CPRT
AEE
10%
AEOS
7%
SRCL
2%
CPRT
4%
M VSN
8%
FR
12%
MS
12%
JKHY
4%
JPM
13%
KM B
10%
FR
JKHY
JPM
KMB
MS
MVSN
SRCL
SRZ
WAG
Holdings as % of Total Market Value
AEOS
SRZ
5%
SRCL
4%
AEE
CPRT
WAG
6%
AEE
6%
FR
M VSN
2%
AEOS
22%
MS
9%
JKHY
JPM
KMB
KM B
6%
MS
CPRT
9%
JPM
13%
JKHY
5%
FR
13%
MVSN
SRCL
SRZ
WAG
Portfolio Fit – Correlation Matrix
AEE
AEOS
CPRT
FR
JKHY
JPM
KMB
MS
MVSN
SRCL
SRZ
WAG
AEE
1
0.155
0.226
0.326
0.196
0.338
0.266
0.255
0.179
0.151
0.09
0.239
AEOS CPRT
1
0.2044
0.1321
0.4141
0.3896
0.2115
0.4217
0.3539
0.21
0.2398
0.3095
1
0.3377
0.2727
0.2462
0.2871
0.2745
0.226
0.0315
0.0847
0.2281
Note: Table assumes equal-weighted portfolio
FR
1
0.237
0.231
0.341
0.265
0.106
0.169
0.171
0.175
JKHY JPM KMB
1
0.498
0.283
0.494
0.397
0.207
0.28
0.31
1
0.272
0.745
0.422
0.28
0.269
0.325
MS
MVSN SRCL
1
0.361
1
0.194 0.489
1
0.311 0.24 0.1317
0.172 0.342 0.2099
0.323 0.434 0.2319
SRZ
1
0.161
1
0.329 0.158
WAG
1
Portfolio Fit – Appraisal Ratio
• Appraisal ratio
: Risk-adjusted measure of excess
returns provided by a security
= alpha/(std error^2)
• Suggests user add (short) the security if alpha is
significant and appraisal ratio is greater than
alternatives
Portfolio Fit – Appraisal Ratio
Appraisal ratio=
α/(std. error^2)
Confidence interval= 90%
AEOS
0.618477765
ANF
0.742700604
GPS
-0.480556986
LTD
0.429232178
Note: All values are significant at 90% confidence
Source Data: Yahoo! Finance
Part 9: Firm Financial
Performance
Firm Financial PerformanceCyclicality and Margin Response
• As shown in the right, AEOS went
through a downturn in FY 2002 and
2003
•"Merchandise assortments not
clearly focused on target
customers" led to "higher
markdowns and increased
promotional activity” AEOS 2003 10-k p. 11
AEOS Source of Sales Y/Y Sales Growth 2001-2005
35.00%
30.00%
25.00%
20.00%
15.00%
non-comparable stores
10.00%
Δ in comparable store sales
5.00%
0.00%
-5.00%
2001
2002
2003
2004
2005
-10.00%
• What was margin response?
•2002: “We were also not able to
leverage selling, general and
administrative expenses as a
result of the negative comp store
sales” AEOS 2002 10-k p. 11
AEOS Margins 2000-2005
100.00%
2000
2001
2002
2003
2004
2005
Gross margin
•2003: "The decline in our gross
profit margin was primarily due to
the deleveraging of rent expense
as a result of weak comparable
store sales…” 2003 10-K p. 11
10.00%
Operating margin
Net profit margin
1.00%
Firm Financial PerformanceRelative Ratios
• Profitability
% Gross margin 5 yr avg
% Operating margin
% Net profit margin
%ROE - 5 yr avg
% ROA - 5 yr avg
AEOS
ANF
GPS
LTD
Industry
42.83
57.9
35.68
36.16
36.9
20.09
19.1
9.36
10.84
10.63
12.84
12.01
5.81
7.22
6.82
26.02
36.68
17.26
30.01
24.02
19.53
20.41
10.32
12
12.1
• Financial Strength/Liquidity
Quick ratio
Current ratio
Long term debt to equity
Total debt to equity
AEOS
ANF
2.65
3.44
0
0
GPS
1
1.9
0
0
LTD
1.52
2.43
9.71
9.71
0.8
1.93
64.99
64.99
Industry
1.03
2.3
20.7
24.1
Financial Management- DuPont
Breakdown
FY
2000
2001
2002
2003
2004
2005
543,046
367,695
672,721
496,792
741,339
571,590
932,414
637,377
1,328,926
963,486
1,605,649
1,155,552
1.48
1.35
1.30
1.46
1.38
1.39
1,093,477
543,046
1,371,899
672,721
1,382,923
741,339
1,435,436
932,414
1,881,241
1,328,926
2,309,371
1,605,649
2.01
2.04
1.87
1.54
1.42
1.44
116,958
1,093,477
147,370
1,371,899
141,469
1,382,923
119,587
1,435,436
281,616
1,881,241
368,731
2,309,371
=Profit margin
10.70%
10.74%
10.23%
8.33%
14.97%
15.97%
=Return on equity
31.81%
29.66%
24.75%
18.76%
29.23%
31.91%
Total assets over
Total equity
=Equity multiplier
Sales over
Total assets
=Total asset turnover
Net income over
Sales
EM*TAT*PM
• Increases in ROE due primarily to greater profit margins
(positive).
Part 10: Valuation
Valuation Method 1: Trading
Multiples
• Step 1: Establish list of comparable firms
Forward:
Trailing:
Ticker
AEOS
AEOS
GPS
LTD
ANF
CHS
FL
URBN
GES
ANN
JCG
PSUN
Company Name
American Eagle Outfitters
American Eagle Outfitters
The Gap Inc.
Limited Brands Inc.
Abercrombie & Fitch Co.
Chicos's Fashions Inc.
Foot Locker Inc.
Urban Outfitters Inc.
Guess? Inc.
Ann Taylor Stores Corp.
J Crew Group Inc.
Pacific Sunwear of California
•
Price
47.06
47.06
19.85
31.64
74.37
23.55
23.21
21.7
63.57
38.81
32.52
18.76
Maret Cap Debt/Assets
EBITDA
6979
0
6979
0
16,446
0
12,496
1/4
6,550
0
4,135
0
3,611
0
3,588
0
2,904
1/9
2,823
0
1,885
2/3
1,301
0
536
536
2,370
1,285
667
347
580
247
134
235
113
260
Retention Rate Price/Sales
Price/Earnings Price/FCF PEG
86%
17.63
86%
2.85
22.41
18.57
86%
1.07
18.73
18.39
64%
1.26
17.78
21.22
84%
2.19
18.5
32.88
100%
2.55
21.03
35.19
81.37%
0.64
14.88
18.09
100%
3.02
31.45
166
100%
2.57
28.13
29.57
100%
1%
19.7
22.45
100% N/A
N/A
N/A
N/A
100%
0.95
16.03
18.68
Criteria used for choosing comparables:
1. Similar size (market cap)
2. Similar capital structure (Debt/Assets)
3. Similar dividend policy (retention rate)
1.29
1.72
1.51
0.99
1.05
1.21
1.39
1.22
1.14
1.42
Trading Multiples
• Step 2: Calculate average multiples
Average Multiples:
Price/Sales=
1.77x
Price/Earnings=
20.03x
Price/FCF=
25.99x
PEG=
1.3x
• Step 3: Apply multiples for firm being valued
Applied to AEOS:
AEOS Salesttm=
AEOS Earningsforward=
AEOS FCFttm=
AEOS PEG=
17 times
1.77 equals
$
29.14
Low Value=
$
22.90
2.67 times
20.03 equals
$
53.48
High value=
$
65.86
2.53 times
17.37 times
25.99 equals
1.32 equals
$
$
65.86
22.90
Median Value=
$
41.31
Valuation Method 2: Discounted Cash
Flow (DCF) Analysis- Base Case
•
Step 1: Forecast FCF
FY 2006 E
Net Sales
Less:
•
2,646,219
Operating Costs
Taxes Paid
Net Investment
Δ Working Capital
= FCF
2,090,708
170,395.31
(215,000.00)
249,758.40
419,873.98
FY 2007 E
3,032,830
FY 2008 E
FY 2009 E
3,475,013
2,351,839
2,599,467
191,433.35 221,181.58
(200,000.00) (15,000.00)
(102,562.95) (532,762.53)
186,994.74 106,601.96
FY 2010 E
3,982,633
4,567,265
2,982,486
252,508.83
(10,000.00)
108,708.61
846,346.77
3,351,337
314,672.72
901,255.34
Step 2: Calculate WACC
we=
100%
ke=
wd=
0
kd=
15%
β=
Tax=
MRP=
1.71
38%
6.50%
Discounted Cash Flow (DCF) AnalysisBase Case
• Step 3: Calculate Terminal Value and Discount
Cash Flows
L-T Growth Rate=
WACC=
4%
16%
1
FY 2006 E
FCF
Terminal
=PV FVF
Total Equity Value=
2
FY 2007 E
3
FY 2008 E
4
FY 2009 E
419,873.98
186,994.74
106,601.96
846,346.77
363165.6591
139894.6239
68979.9145
473687.1551
5,388,548.07
5
FY 2010 E
901,255.34
8,069,785.19
4342820.715
DCF Analysis- Base Case
• Step 4: Subtract debt and divide by shares
outstanding to arrive at intrinsic value
Less:
Over:
Total Equity Value=
L-T Debt
=Firm intrinsic value
Common shares outstanding
=Value per common share
5,388,548.07
0
5,388,548.07
145,931.00
$
+ 10%
$
40.62
- 10%
$
33.23
36.93
WACC
DCF Analysis- Base Case
Sensitivity Analysis
11%
12%
13%
14%
15%
16%
17%
18%
19%
2.00%
53.19
47.05
42.05
37.91
34.43
31.47
28.92
26.70
24.76
2.50%
55.85
49.11
43.69
39.23
35.52
32.37
29.68
27.35
25.31
3.00%
58.84
51.41
45.49
40.68
36.69
33.34
30.49
28.03
25.90
Long-term growth rate
3.50%
4.00%
4.50%
62.23
66.10
70.58
53.97
56.86
60.13
47.48
49.70
52.18
42.26
44.00
45.93
37.97
39.37
40.90
34.39
35.53
36.76
31.36
32.30
33.31
28.76
29.55
30.39
26.52
27.18
27.89
5.00%
75.79
63.87
54.96
48.07
42.58
38.11
34.41
31.30
28.65
5.50%
81.95
68.18
58.12
50.46
44.44
39.59
35.61
32.28
29.46
6.00%
89.35
73.21
61.72
53.14
46.50
41.21
36.91
33.34
30.34
However…
DCF Analysis- Downside Scenario
• The DCF value just presented assumes
steady annual growth of approximately
15%
– Although AEOS has demonstrated an ability
to grow at extremely high rates (over 15%),
one cannot forget the firm’s susceptibility to
shifts in consumer preference (fashion)
DCF Analysis- Downside Scenario
• Let’s assume that for whatever reason, AEOS
experiences a 2-year downturn in comparable
store sales similar to the one experienced in
2002-2003
Downside Sales Projections 2001-2010
FY 2010 E
FY 2009 E
FY 2008 E
FY 2007 E
FY 2006 E
FY 2005
FY 2004
FY 2003
FY 2002
% y/y new store sales
% y/y comp sales
FY 2001
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
-5.00%
-10.00%
DCF Analysis- Downside Scenario
• Under this downside scenario, we see that the
DCF-generated stock price decreases
significantly
Less:
Over:
Total Equity Value=
L-T Debt
=Firm intrinsic value
Common shares outstanding
=Value per common share
3,154,038.48
0
3,154,038.48
145,931.00
$
+ 10%
$
23.77
- 10%
$
19.45
21.61
WACC
DCF Analysis- Downside Scenario
Sensitivity Test
11%
12%
13%
14%
15%
16%
17%
18%
19%
2.00%
30.77
27.31
24.50
22.17
20.21
18.55
17.11
15.86
14.77
2.50%
32.26
28.47
25.42
22.92
20.82
19.05
17.54
16.22
15.08
3.00%
33.94
29.76
26.44
23.73
21.49
19.60
17.99
16.61
15.40
Long-term growth rate
3.50%
4.00%
4.50%
35.85
38.02
40.53
31.20
32.82
34.66
27.56
28.80
30.19
24.62
25.60
26.68
22.20
22.99
23.85
20.19
20.83
21.52
18.48
19.01
19.58
17.02
17.46
17.93
15.75
16.12
16.52
5.00%
43.46
36.76
31.75
27.88
24.79
22.28
20.19
18.44
16.95
5.50%
46.93
39.18
33.53
29.22
25.83
23.11
20.87
18.99
17.41
6.00%
51.08
42.01
35.55
30.73
26.99
24.02
21.60
19.59
17.90
Valuation Methods Compared
Valuation Methods- DCF and Trading Multiples
DCF
23.77
Trading Multiples
22.90
-
20.00
$33.89
44.00
$41.31
40.00
65.86
60.00
80.00
100.00
120.00
140.00
Part 11: Recommendation
Recommendation
•
Firm direction
– Martin + Osa
– Margins
•
•
Diversification
Valuation
– Trading multiples
• The trading multiples approach suggests a price similar to that at which AEOS is
currently trading
• This price relies on the firm’s past sales, earnings, and free cash flow numbers and
thus, would be prone to overvaluation, especially when used in a long-term investment
decision
– DCF
• Although our DCF model is somewhat crude, we feel that the insight added by
accounting for a downturn in sales shows, in a very dramatic way, the downside risk
inherent in the company
•
In summary, we believe that American Eagle Outfitters’ strong performance
in recent periods has caused unrealistic market expectations for the firm’s
future performance, thus inflating the price
Recommendation
• Our recommendation, therefore is to sell
approximately 24% or 400 shares of AEOS at the
market
– Realized capital gain approx.= $15,664
Holdings as % Total Market Value: Post-Sale
AEE
AEOS
6%
CPRT
7%
7%
FR
4%
18%
2%
JPM
9%
KMB
9%
6%
13%
JKHY
MS
MVSN
5%
14%
SRCL
SRZ
WAG
Questions?