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American Eagle Outfitters (AEOS)

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”

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American Eagle Outfitters (AEOS)

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  1. American Eagle Outfitters(AEOS) Dan DeRose Matthew McDonnell 14-November-2006

  2. 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

  3. Part 1: Company overview

  4. 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 stand-alone stores and internet sales • Geography: • Stores in all 50 states, Puerto Rico, and Canada • Limited online sales to locations outside USA

  5. 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

  6. Part 2: RCMP Position

  7. 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

  8. 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%

  9. Part 3: Macroeconomic and Market Overview

  10. Macroeconomic/Market Overview • Macroeconomic overview • Economic growth in Q2, Q3 2006 lower versus previous year

  11. Macroeconomic/Market Overview • Consumption spending • Weak y/y summer • Strong y/y fall

  12. Macroeconomic/Market Overview • Clothing and shoe spending steady since 2003 • 2006 Q1, Q3 stronger y/y, 2006 Q2 significantly weaker

  13. 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

  14. Part 4: Industry Overview

  15. Industry Overview- Specialty Clothing Retailers

  16. Part 5: Firm Strategy and Development

  17. 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

  18. 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

  19. 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

  20. 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 10-15 in 2007

  21. Firm strategy and development • Expanding distribution centers in Kansas to support further growth of AE and Martin + Osa

  22. Firm strategy and development • Recently, the firm has stressed expansion into the Southwest US 2000 2002 2004 2005

  23. Part 6: Stock Performance

  24. 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

  25. Stock Performance • AEOS has outperformed S&P and NASDAQ for 5 yr. and 6 mo. intervals

  26. AEOS has outperformed competitors ANN, ANF, and LTD for 5 yr. and 6 mo. intervals Stock Performance

  27. Part 7: Portfolio Fit

  28. Portfolio Fit- Diversification • 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

  29. Portfolio Fit – Correlation Matrix Note: Table assumes equal-weighted portfolio

  30. 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

  31. Portfolio Fit – Appraisal Ratio Note: All values are significant at 90% confidence Source Data: Yahoo! Finance

  32. Part 9: Firm Financial Performance

  33. Firm Financial Performance- Cyclicality 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 • 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 • 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

  34. Firm Financial Performance- Relative Ratios • Profitability • Financial Strength/Liquidity

  35. Financial Management- DuPont Breakdown • Increases in ROE due primarily to greater profit margins (positive).

  36. Part 10: Valuation

  37. Valuation Method 1: Trading Multiples • Step 1: Establish list of comparable firms • Criteria used for choosing comparables: • Similar size (market cap) • Similar capital structure (Debt/Assets) • Similar dividend policy (retention rate)

  38. Trading Multiples • Step 2: Calculate average multiples • Step 3: Apply multiples for firm being valued

  39. Valuation Method 2: Discounted Cash Flow (DCF) Analysis- Base Case • Step 1: Forecast FCF • Step 2: Calculate WACC

  40. Discounted Cash Flow (DCF) Analysis- Base Case • Step 3: Calculate Terminal Value and Discount Cash Flows

  41. DCF Analysis- Base Case • Step 4: Subtract debt and divide by shares outstanding to arrive at intrinsic value

  42. DCF Analysis- Base Case Sensitivity Analysis

  43. However…

  44. 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)

  45. 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

  46. DCF Analysis- Downside Scenario • Under this downside scenario, we see that the DCF-generated stock price decreases significantly

  47. DCF Analysis- Downside Scenario Sensitivity Test

  48. Valuation Methods Compared

  49. Part 11: Recommendation

  50. 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

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