You are using an older browser version. Please use a supported version for the best MSN experience.

Is American Eagle Outfitters an Undervalued Dividend Stock?

The Motley Fool logo The Motley Fool 12/15/2018 Leo Sun

a person sitting on a bench: Aerie activewear.© Aerie Aerie activewear. American Eagle Outfitters(NYSE: AEO) recently reported mixed third-quarter earnings and soft guidance for the holiday quarter. The apparel retailer's revenue rose 5% year over year to $1 billion, narrowly missing expectations by $20 million, as its comparable-store sales climbed 8% -- which also missed the consensus forecast for 8.4% growth.

AEO's earnings per share rose 33% to $0.48, beating estimates by a penny. But for the fourth quarter, it only expects to post earnings of $0.40 to $0.42 per share. That missed the consensus forecast of $0.45 and represents a 19% to 23% year-over-year decline in its reported EPS (which included a one-time tax benefit last year), or a 5% to 9% decline in its adjusted EPS (which excluded that benefit).

That lower forecast initially torpedoed AEO's stock, but it recovered after investors realized that the guidance was affected by an extra week in 2017. The loss of that extra week shaved $60 million in revenue and $0.07 of EPS from its forecast. Excluding the impact of losing a week, AEO's forecast would imply a 7% to 11% rise in adjusted EPS for the fourth quarter.

AEO currently trades at less than 12 times its projected earnings for next year and pays a forward dividend yield of 3%. Do those figures indicate that AEO is an undervalued dividend stock? Let's take a closer look at its business to find out.

A best-in-breed retailer with strong growth engines

AEO generates most of its revenue from its American Eagle stores, but an increasing proportion of its sales comes from Aerie, its lingerie and activewear brand for young women. Aerie has posted double-digit comps for 16 straight quarters, and that streak -- which offsets American Eagle's slower growth -- isn't likely to end anytime soon.

Brand

Q3 2017

Q4 2017

Q1 2018

Q2 2018

Q3 2018

American Eagle

1%

5%

4%

7%

5%

Aerie

19%

34%

38%

27%

32%

Total

3%

8%

9%

9%

8%

Comp sales growth by brand. Data source: AEO quarterly reports. Chart by author.

Aerie gained a loyal following as an "anti-Victoria's Secret" with untouched ads featuring models of all sizes in body-positive marketing campaigns. That growth has clearly hurt L Brands(NYSE: LB), which reported a 2% comp sales decline for its Victoria's Secret brand last quarter.

a group of people around each other: Four girls wearing winter apparel from Aerie© Aerie Four girls wearing winter apparel from Aerie

Meanwhile, American Eagle remains a beacon for younger shoppers. In Piper Jaffray's latest "Taking Stock with Teens" survey, American Eagle was ranked as the second-favorite clothing brand for U.S. teens (after Nike), and their third-favorite shopping website (after Amazon and Nike).

During the company's recent earnings call, CEO Jay Schottenstein attributed the growth of AEO's two core brands to "extremely well-executed back-to-school and fall seasons." American Eagle continued to attract shoppers with its denim products, while Aerie continued to lock in customers with its AerieREAL marketing campaigns and new bras.

AEO's gross margin expanded 80 basis points year over year to 39.8%, thanks to lower markdowns and rent leverage. Its adjusted operating margin dipped 70 basis points to 10.8% due to the calendar shift, but has risen 40 basis points on a year-to-date basis, to 8.5%. By comparison, L Brands reported adjusted gross margin of 36.9% last quarter with an adjusted operating margin of 5.6% -- and both figures fell from a year earlier.

Is AEO an undervalued dividend stock?

Analysts expect AEO's revenue and EPS to rise 6% and 10%, respectively, next year. They also expect its annual earnings to grow at an average rate of 13% over the next five years, which gives it a 5-year PEG ratio of 1.0. Since a PEG ratio under 1 is considered undervalued, AEO looks inexpensive (but not necessarily cheap) relative to its long-term earnings growth potential.

However, AEO doesn't consistently raise its dividend. It hiked its quarterly payout earlier this year, but that represented its first dividend increase in five years. On the bright side, AEO's estimated EPS of $1.61 next year should comfortably cover its $0.55 per-share dividend with a payout ratio of 34% -- giving it plenty of room for future dividend growth.

I personally like AEO as a best-in-breed play on the tough apparel sector, and it's cheaper than many of its industry peers. However, I wouldn't buy it only as an income investment, since there are plenty of other stocks that pay higher yields and trade at lower valuations.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Nike. The Motley Fool has a disclosure policy.

SPONSORED:

10 stocks we like better than American Eagle Outfitters

When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and American Eagle Outfitters wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of November 14, 2018

AdChoices
AdChoices

More from The Motley Fool

The Motley Fool
The Motley Fool
image beaconimage beaconimage beacon