American Eagle's new flight pattern?
Over the past 10 years, the eagle has soared into the stratosphere. From about 1 dollar a share in 1997, American Eagle's stock price rose to over 30 in 2007. Like poor Icarus, who flew too close to the sun and ended up in the Icarian Sea, American Eagle's wings are now damaged, and its new flight pattern is unfortunately down.
American Eagle's new same stores sales were just released. Down 12% from last March. Total sales were down 2%. Ouch! But wait, the numbers get even worst. AEO is now lowering its earnings guidance to .18 - .20 cent a share for the first quarter of 2008. This is about 50% less than last year. Also since last March, AEO has bought back about 8% of its outstanding shares, so actual net earnings will be down about 55% from last years Q1. Margins are obviously getting squeezed big time.
What should also concern investors is that just one month ago, AEO published an estimate of .26 cent a share for the first quarter. This new estimate is a 27% reduction from AEO's estimate form just 30 days ago. This calls into question whether upper management really knows what is happening on the ground.
This article from just a few day ago presents the bull case for American Eagle. The author did a great job of showing how well AEO has done in the past. The data shows AEO's remarkable growth from 1998 to 2006. But as stated above, American Eagle's stocks price had risen 30x during that time as well.
But one can not ignore the last 4 quarters when trying to predict future cash flows IMHO. Here is a chart of what I call earnings velocity. This is the past 4 quarters of AEO's net earnings year on year growth rates. I am including AEO's most recent estimate for Q1.
As you can see, earnings growth has fallen from a 5 year average of 33%, to flat, and now for the first quarter of 2008 a 55% reduction in net earnings. I believe this trend will continue. Consumer spending during this US recession will be soft. Also Aéropostale, AEO's teen competitor, posted 14% sales increase, with same store sales increase of 2.5%. This shows that American Eagle is losing market share as well, and underperformed its peers.
While the new baby eaglet's concept looks promising, the more upscale M&O concept has been a failure and a major drag on earnings and cash flow. Free cash flow for the year ending Feb. 2008 was about 270 million, verses last years amount of 525 million - a decrease of 50%. I estimated AEO's Q4 cash flows from its balance sheet since the eagle failed to report cash flows in its earnings release. A quick note to all public firms - always report your cash flows with your results!
As if American Eagle needed any more bad news, their short term investments balance in now a question mark. As of year ending Feb. 2008, AEO had $418 million of investments in auction rate securities (“ARS”). This ARS amount is on the balance sheet as a current asset in "short term investments". But since then, other retailers like Best Buy have moved their ARS balance out of short term investments and into long term investments(out of current assets). AEO may be forced to do the same, lowering its current ratio. AEO has also stated that future impairment charges may be needed for these ARS's.
My estimate for AEO's current year is now for earnings per share of $1.30. My free cash flow estimate is 200 million for this current year. This would give AEO a free cash flow yield of 5.8%. This yield is too low for me to invest in a firm with declining fundamentals. My current discounted cash flow value for AEO is now 2.8 billion, or 13.75 a share.
Longer term, I hope the eagle still has some wax left on its wings, but if American Eagle gets wet don't blame me or Daedalus.