(AEO) American Eagle Outfitters to Exit 77kids Business

American Eagle Outfitters Inc. (AEO), a specialty retailer of casual apparel, accessories and footwear for men, women and kids, announced its plans to do away with its children’s brand (77kids). The business generated net sales of $40 million in the fiscal year 2011, on which it incurred a loss of around $24 million.

Management further said that the company will emphasize on their core business from now on, thus generating the best possible return. As a result, management had to take the tough decision of closing down one of its brands.

77kids is mainly targeted for the age group of 2-14 years and was launched in the year 2008 as an online brand; but currently also operates through 22 standalone stores across North America.

The company is on the look out for full or partial disposition of the 77kids assets, which is likely to be completed by the end of the current fiscal year.

Management expects the pay-offs related to the disposition of the business to be allocated in the second and third quarters of 2012. However, the company has not yet made any financial disclosures.

The company has also not mentioned the magnitude of headcount reduction as a result of the closure of 77kids.

American Eagle will release its first-quarter financial results on Wednesday, May 23, 2012. The results will exclude the operations of 77kids.

Neutral on American Eagle

Looking ahead into 2012, the company sees a modest rise in sales and slight improvement in margin. The company expects margins to be under pressure in the first half of fiscal 2012 due to higher product costs. The company expects first-quarter earnings to come in the range of 8 cents – 10 cents per share compared with 13 cents in the prior-year period, hurt by continued margin pressure from higher product costs, higher markdowns and the potential for increased promotions.

However, we are impressed with the company’s continued momentum in denim along with improved merchandise assortments in the women’s business segment, which will likely lead to a turnaround in its top line as well as a rebound in gross margin in the second half of the year.

The company, which faces stiff competition from Abercrombie & Fitch Co. (ANF) and Gap Inc. (GPS), is continuously taking steps to reduce costs through supply chain efficiencies and an updated product-allocation system, intending to boost its bottom line.

Further, management’s efforts to boost cash flow and maintain a debt-free, healthy balance sheet bode well for future operating performance.

Therefore, the company carries a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating, and we also remain ‘Neutral’ on a long-term basis.

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