(AEO) American Eagle Outfitters Profits Jump – Guides Higher

American Eagle Outfitters Inc.‘s (AEO) adjusted earnings of 21 cents per share for the second quarter of fiscal 2012 climbed nearly 62% from the prior-year quarter’s adjusted earnings of 13 cents. The year-over-year growth in earnings were driven by a double-digit growth in top line, coupled with lower input and operating expenses. Moreover, quarterly adjusted earnings were in line with the Zacks Consensus Estimate.

Adjusted figures do not include income generated from 77Kids business, since the company announced its plan to exit from children’s business in May 2012. On a reported basis, including loss from discontinued business, the company earned 9 cents per share compared with 10 cents in the year-ago period.

Quarter in detail

During the quarter, American Eagle’s adjusted net sales went up 11% year over year to $739.7 million, while beating the Zacks Consensus Estimate of $738 million. Growth in revenue was driven by a 9% increase in comparable store sales compared with a rise of 1% registered in the year-ago quarter.

The company’s AE Brand, aerie and AEO Direct segments reported a growth of 7%, 13% and 28%, respectively, in comparable store sales.

Adjusted gross profit increased 17% to $276.6 million, while gross margin improved 210 basis points (bps) to 37.4%. The year-over-year increase in gross profit and margin was primarily driven by strong top-line performance along with lower cost of goods sold and a benefit of 90 bps rising from leveraged buying, occupancy and warehousing expenses.

Adjusted selling, general and administrative (SG&A) expense increased 9.1% to $178 million. However, as a percentage of sales, it improved 40 bps to 24% compared with 24.4% in the prior-year quarter. Adjusted figure excludes the $4 million expense incurred during the quarter towards restructuring purpose.

Consequently, adjusted operating income surged 76% to $67 million. Moreover, adjusted operating margin expanded 340 bps to 9.1%, primarily due to increased sales, lower input costs and leveraged SG&A expenses.

Financial Position

American Eagle ended the quarter with cash and short term investments of $702 million compared with $514 million in the year-ago period. During the first six months of fiscal 2012, the company generated $47.7 million cash from operating activities while it deployed $48.2 million toward capital expenditure.

The company’s total inventory was $462 million at the end of second quarter compared with $457 million in the prior-year period. Cost per square foot was up 3% from the previous-year quarter.

Guidance

Looking ahead into fiscal 2012, the company raised its earnings guidance range to $1.33 – $1.36 per share from $1.16 – $1.22 forecasted earlier. The improved guidance range is based on the company’s expectation of mid-single-digit and low-sing-digit growth in comparable store sales for third and fourth quarters of fiscal 2012. Moreover, the company still anticipates incurring a capital expenditure of $100 million in fiscal 2012.

For the third quarter of fiscal 2012, American Eagle expects to earn in the range of 37 – 38 cents per share compared with 30 cents in the prior-year period. In addition, the company is anticipating a decline in the range of mid-single-digit in inventory per square foot.

Our Recommendation

American Eagle now plans to focus more on merchandise assortments, adding more compelling brands, managing inventory level much diligently and augmenting e-commerce business. Further, in order to emphasize more on the core business while generating the best possible return for shareholders, the company has decided to exit its children’s brand, 77Kids.

We remain impressed with the company’s continued momentum in denim along with improved merchandise assortments in the women’s business segment, which will likely augment its top-line performance as well as enhance the gross margin.

Moreover, we believe that American Eagle’s cost-saving initiatives and long-term growth strategy will not only provide financial flexibility, but will also help to drive value proposition. In an effort to boost its bottom line, the company is relentlessly focusing on initiatives to cut down costs through supply chain efficiencies and updated product allocation system.

American Eagle, which competes with Abercrombie & Fitch Co. (ANF) and Gap Inc. (GPS), carries a Zacks #2 Rank, translating into short-term Buy rating for the next 1-3 months. Moreover, we maintain our long-term ‘Outperform’ recommendation on the stock.

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