American Eagle Outfitters (AEOS)

1
American Eagle Outfitters(AEOS)

• Dan DeRose
• Matthew McDonnell

14-November-2006
2
Presentation Outline

• Company overview
• RCMP Position
• Macroeconomic/Market overview
• Industry overview
• Porters 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

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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

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• Part 2 RCMP Position

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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

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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

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• Part 3 Macroeconomic and Market Overview

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Macroeconomic/Market Overview

• Macroeconomic overview
• Economic growth in Q2, Q3 2006 lower versus
  previous year

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Macroeconomic/Market Overview

• Consumption spending
• Weak y/y summer
• Strong y/y fall

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Macroeconomic/Market Overview

• Clothing and shoe spending steady since 2003
• 2006 Q1, Q3 stronger y/y, 2006 Q2 significantly
  weaker

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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

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• Part 4 Industry Overview

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Industry Overview- Specialty Clothing Retailers
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• Part 5 Firm Strategy and Development

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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

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Firm strategy/development

• Product Mix
• Product mix has remained constant last several
  years with slight shifts toward womens apparel
  and accessories at the expense of mens apparel
  and accessories

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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

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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

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Firm strategy and development

• Expanding distribution centers in Kansas to
  support further growth of AE and Martin Osa

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Firm strategy and development

• Recently, the firm has stressed expansion into
  the Southwest US

2000 2002
2004 2005
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• Part 6 Stock Performance

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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

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Stock Performance

• AEOS has outperformed SP and NASDAQ for 5 yr.
  and 6 mo. intervals

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Stock Performance

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

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• Part 7 Portfolio Fit

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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

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Portfolio Fit Correlation Matrix
Note Table assumes equal-weighted portfolio
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Portfolio Fit Appraisal Ratio

• Appraisal ratio
• Risk-adjusted measure of excess returns
  provided by a security
• alpha/(std error2)
• Suggests user add (short) the security if alpha
  is significant and appraisal ratio is greater
  than alternatives

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Portfolio Fit Appraisal Ratio
Note All values are significant at 90 confidence
Source Data Yahoo! Finance
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• Part 9 Firm Financial Performance

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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

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Firm Financial Performance- Relative Ratios

• Profitability

• Financial Strength/Liquidity

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Financial Management- DuPont Breakdown

• Increases in ROE due primarily to greater
  profit margins (positive).

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• Part 10 Valuation

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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)

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Trading Multiples

• Step 2 Calculate average multiples
• Step 3 Apply multiples for firm being valued

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Valuation Method 2 Discounted Cash Flow (DCF)
Analysis- Base Case

• Step 1 Forecast FCF
• Step 2 Calculate WACC

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Discounted Cash Flow (DCF) Analysis- Base Case

• Step 3 Calculate Terminal Value and Discount
  Cash Flows

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DCF Analysis- Base Case

• Step 4 Subtract debt and divide by shares
  outstanding to arrive at intrinsic value

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DCF Analysis- Base Case Sensitivity Analysis
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• However

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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 firms susceptibility to shifts in
  consumer preference (fashion)

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DCF Analysis- Downside Scenario

• Lets assume that for whatever reason, AEOS
  experiences a 2-year downturn in comparable store
  sales similar to the one experienced in 2002-2003

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DCF Analysis- Downside Scenario

• Under this downside scenario, we see that the
  DCF-generated stock price decreases significantly

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DCF Analysis- Downside Scenario Sensitivity Test
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Valuation Methods Compared
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• Part 11 Recommendation

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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 firms 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 firms future performance, thus inflating the
  price

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Recommendation

• Our recommendation, therefore is to sell
  approximately 24 or 400 shares of AEOS at the
  market
• Realized capital gain approx. 15,664

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• Questions?