Description

Thesis

American Eagle Outfitters is fast growing intimates and other specialty apparel company masquerading as a teen retailer. AEO has 2 businesses: the high growth primarily direct to consumer Aerie business and the stable cash generating low growth mall based American Eagle retail banner. AEO currently trades around 6x 2022 EBITDA, a multiple ascribing little value to Aerie despite it being the fastest growing $1 billion concept in retail over the last 3 years. Aerie even grew revenues 25% in 2020! 

AEO’s recent decision to disclose more information on the Aerie business is likely a precursor to a separation of the 2 businesses sometime in the next couple of years. Aerie has become self financing and no longer needs to access the cash flows from the mature AE business to grow.

Meanwhile, the AE business should see a significant revenue and EBITDA rebound in 2021 as the economy reopens and kids return to schools and colleges. AE should see a significant rebound in revenues and EBITDA in 2021 and 2022 off of the pandemic lows of 2020.

If AEO can achieve the 2023 Aerie and AE targets the company outlined at its January investor day for the 2 businesses, on a sum of the parts basis the company would be worth over $50/share, nearly double the current price. At the current share price of AEO, you are buying Aerie for ~13x 2023 EBITDA (a substantial discount to high growth consumer peers) and getting the AE business with its ~$375MM in EBITDA (including all of the unallocated corporate expenses) for “free.”  

Overview
American Eagle operates and licenses over 1,300 retail stores worldwide as well as direct to consumer ecommerce websites at www.ae.com and www.aerie.com in the U.S. and internationally. AE has been rationalizing its physical store footprint while the Aerie brand continues to add new locations. 

The company states that its “brands are connected under the core tenet of REAL, which is inclusive, optimistic, empowering and celebrates self-expression. Our purpose is to show the world that there's REAL power in the optimism of youth.”

On a consolidated basis, the product drivers are the denim business of the AE brand and the intimates and the athleisure brands sitting under the Aerie brand.   

On a consolidated basis, AEO has grown ecommerce sales at a 22% CAGR over the last 5 years. According to the company, ecommerce sales actually have higher gross margins than store sales.   

At its January investor day, management outlined plans to grow the consolidated company by 6% on the topline and 15% on the EBIT line over the next 3 years driven by a 26% CAGR in the Aerie business and flat revenues in the AE business vs. 2019. We believe these targets are likely to end up being conservative. 

American Eagle

The American Eagle brand caters mostly to teenagers and young adults and is most associated with its denim business where the company holds a leadership position in women’s jeans -- especially in the 15-25 year old demographic. 

Among its core demographic, the AE brand scores highly, just behind Nike as a favorite brand.  

American Eagle stores are ubiquitous across the U.S. and in all types of malls and outlets.  Given the headwinds to malls, the company is actively closing unprofitable or marginally profitable stores while also shortening lease duration and negotiating lower rents. The company closed 52 stores in 2020 (~5.5% of the AE stores) and has announced plans to close 180-280 stores over the next 3 years.

The American Eagle brand had low single digit topline growth pre-pandemic in spite of annual store closures in the ~5% of the store base range. 

The company believes that it will return the AE brands topline back to 2019 levels by 2023 while expanding operating margins by 70bps/year through the natural margin improvement of closing down unprofitable stores as well as improving economies of scale in the company’s ecommerce business. 

Aerie

The Aerie business started as an online only distribution channel to sell “The Original Boy Brief” underwear for teenage girls. The remarkable success of that product selling originally exclusively online (subsequently in AE stores) caused AEO management to decide to start to build out the Aerie intimates brand. Aerie grew as mostly an ecommerce company with store within a stores inside of Aerie stores. As the brand continued to demonstrate significant growth, AEO started to build standalone Aerie stores. 

Aerie currently has 342 stores comprised of 175 standalone stores and 167 Aerie store within a stores inside of AE locations. Over 43% of Aerie sales come from its ecommerce site. The Aerie brand is dramatically more penetrated in the Eastern States with the brand having significant penetration opportunities in CA, TX, and other Western states.

Aerie new stores are currently quite profitable on a 4 wall basis and easily exceed the company’s 15% hurdle rate for new store construction. The company plans to expand the Aerie store base by roughly 20% a year over the next 3 years. 

One of Aerie’s keys to success over the past 5 years has been its early embrace of the “body positivity” movement. 

Aerie’s advertising uses non-airbrushed and often plus sized models signaling a much more inclusive nature of the brand versus competitors like Victoria’s Secret. Aerie’s messaging has been winning over customers as Victoria’s Secret/Pink have struggled to adapt to changing social trends. 

Aerie has been the fastest growing retail brand to reach $1 billion in sales since it’s debut in 2007. It has been growing revenue at a 25% CAGR for the last 6 years (including 2020.) The business grew 25% in 2020  because the business already had a robust ecommerce business pre-pandemic. Aerie was the fastest growing public retail brand for the 3 years before the pandemic.

Aerie has sustained 25%+ topline growth by expanding categories from intimates into beauty, swim, soft apparel, and activewear. Aerie is incubating an active wear brand called “Offline” inside of the Aerie business. Offline is a $200MM business today up from $15mm 5 years ago. The activewear market is a $21 billion market.  From the look of things, the push to adjacent categories from intimates is going well.  

Aerie’s activewear products are dramatically more affordable than peers which should provide the company with additional room to grow as the more value oriented retailer of sports bras and leggings. 

You don’t have to stretch to see the similarities between Aerie and where Lululemon was in 2013. LULU finished 2012 with $1B in revenue with only 16% of sales from DTC. Fast forward 8 years and LULU finished 2020 with $4B in revenue (52% from DTC) with customers that love the product AND message that LULU is selling.  Aerie is already 43% DTC with both new stores and ecom providing growth opportunities.

To compare, Aerie just finished 2020 with $1B in revenue, and has been the fastest growing brand since it’s debut. I’m not saying this is LULU 8 years ago, but the similarities are stunning...right down to the see thru issues with their most recent hot leggings that just can’t seem to stay in stock due to viral marketing. Aerie’s “Real Me” leggings went viral and were sold out for most of 2020 after TikTok star Hannah Schlenker filmed a TikTok dance video wearing a pair. At $45, Aerie’s Real Me leggings are dramatically more affordable for teenagers and young adults than Lululemon’s Align leggings which retail for $100.   

Just to point out the strength of Aerie, it has been growing 25% the past 6 years, and this includes the last year when COVID caused many retailers to stumble. 

At the analyst day, they mentioned that ”Aerie revenue is expected to grow at a mid-20%'s compound annual growth rate to ~$2B.”  The projected revenue growth appears conservative given the growth in adjacent markets and their strong relationships with their customer base. Aerie has hit an inflection point in its profitability and management expects Aerie operating margins to expand by 700bps to 15.5% over the next 3 years.

The projected revenue growth is expected to be come mostly from the digital channel with growth also coming from store comps and new stores. 

Capital structure

In April 2020 in the height of the pandemic, American Eagle issued $415 million in convertible senior notes due in 2025 paying 3.75%. The converts are convertible at $8.69/share. AEO does not have the right to redeem the Notes prior to April 17, 2023. Management has indicated that they plan on redeeming the converts when they first can in April 2023 with a cash payment at par and the rest of the redemption payment paid in stock.

Outside of this convert, they have no other long term debt.  They have a clean net cash balance sheet with sufficient cash on balance sheet already to make the redemption payment on the convert in 2023. Historically they return about 60% of operating cash flow to shareholders and spend 40% on capex. With the AE business having minimal capex. On March 3rd, the company reinstated its quarterly dividend and unsuspended its share repurchase program.

Valuation

Over the last decade, AEO has traded at similar multiples to other teen retailers (3-8x EV/EBITDA). Aerie, as the fastest growing concept since it’s debut, would likely trade at a much higher multiple if it were separated. We believe an independent Aerie should trade at a similar multiple to other high growth retailers like LULU (25x), VfC (16.7x) or NKE (22x). At 20x 2023 EBITDA for Aerie and 6x 2023 EBITDA for AE, AEO would be worth over $50/share. At a more conservative 15x 2023 EBITDA for Aerie and 6x 2023 EBITDA for AE, the stock would be worth about $40 per share.  

Catalyst

Earnings/comps over the course of 2021 as they start cycling covid sales demonstrating the rebound in the AE business
Multiple expansion as the continue to increase disclosure around the Aerie business and the street gets a greater appreciation for the growth inherent in the Aerie busines
Spinning out of Aerie business or the sale of the AE business