All retailers have had a tough run over the past few years, as e-commerce gained popularity, but no one has suffered more than the stores based in shopping malls. As mall traffic declined, the massive structures started to look more like ghost towns, as, one by one, stores started to close their doors. That, in turn, hurt traffic even further and weighed on the remaining few who were able to continue operating.
However, not all mall-based retailers have been abandoned — a few have been able to change with the times by improving their online presence and continuing to attract customers despite the lack of interest in shopping at malls. American Eagle Outfitters (NYSE: AEO) is one such retailer that has been able to buck the retail trend and give investors some positive gains.
How to Survive Amazon
American Eagle stock was an unlikely survivor of the retail apocalypse — the company’s stores are based in shopping malls and fast-fashion alternatives threatened to poach the firm’s customer base. Luckily, management was able to dodge the Amazon.com Inc. (NASDAQ:AMZN) bullet by leveraging the company’s sister brand, Aerie. Aerie sells lingerie and active wear to teens and, from the beginning, AEO positioned it as a positive body-image brand, something that has resonated well and garnered a lot of attention.
In the fourth quarter, AEO was able post some pretty impressive results, namely the firm’s 8% comparable sales growth. That figure was helped immensely by Aerie which saw 34% growth during the quarter. The momentum that Aerie brought to the table wasn’t the only thing management was happy about — American Eagle’s namesake brand also turned in respectable 5% growth.
What’s Not to Love?
With those figures in front of you, the stock might be looking pretty tempting, especially considering that the company trades at just 15 times its forward earnings and has no long-term debt. However, following the fourth quarter earnings call, AEO stock sunk — and rightly so.
Yes, AEO was able to grow, but the company’s gross margin fell 80 basis points from the previous year. The reason for that slide was largely promotional activity, which doesn’t paint an encouraging picture of the firm’s future.
Heavily discounted products will, of course, increase sales but at the expense of profitability and investors are wise to question that strategy. Although management insisted that the firm was on track to continue growing in the year to come, it’s worth considering what that growth will cost.
Retail is a risky place to operate, especially for companies like AEO that are still at least partially relying on shopping malls. That fact alone should compound investors’ worries about American Eagle stock. Would we still see respectable growth at both American Eagle and Aerie if the promotions hadn’t been in place? It’s tough to say for sure, but it’s unlikely.
It’s also worth noting that American Eagle stock is currently trading at 5-year highs. That means there’s a lot to lose if investors start to lose confidence or the company receives any bad news. If American Eagle sees a sales-growth slide in the coming quarter, investors are likely to pull back. Even if sales growth continues but margins remain under pressure, investors could turn on the stock.
The point is that AEO hasn’t convinced me that it’s fully on the upswing yet. What management has done with a business that should have been left for dead in the new retail landscape is certainly commendable and there’s no question that the Aerie brand momentum is strong right now — but I’m not willing to bet on that for the long-term, at least not while AEO stock is trading so high.
The Bottom Line on American Eagle Stock
With the stock at fresh 5-year highs, AEO stock is simply too risky. Aerie’s popularity is helping drive momentum right now, but fashion is fickle and it would be irresponsible to take a long term position based solely on that.
I’d say now is a good time to take profits and investors who are interested in adding American Eagle stock to their portfolios might want to wait for the next quarterly results to come out before jumping on board.
As of this writing Laura Hoy was long AMZN.