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American Eagle Apparel Stores. Final Valuation By: Nick Cecero. Apparel Stores Industry. U.S. apparel m arket is considered a mature market. 2013 sales at clothing and clothing accessory stores increased 3.8%. (Down from 5.5% in 2012)
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American Eagle Apparel Stores Final Valuation By: Nick Cecero
Apparel Stores Industry • U.S. apparel market is considered a mature market. • 2013 sales at clothing and clothing accessory stores increased 3.8%. (Down from 5.5% in 2012) • Dramatic shift from clothing to household goods, and cars. • According to S&P analysts they forecast apparel sales growth to be 3% to 4% in 2014. • Discretionary youth spending has been centered toward consumer electronics and entertainment services.
Recent Earnings Announcement Highlights • Net revenue decreased 6.7% year over year for the fourth quarter (supposed to be where majority of the sales come from) • Net income was $10.5 million for Q4 2013 compared to net income $94.8 million in Q4 of 2012. • Fiscal Year 2013 net income was $83 million compared to fiscal year 2012 net income of $232.1 million.
Forward Outlook Perspective From American Eagle • “Expectations” driven we care about where a company is going and the steps they are taking to achieve long term growth. • Forward outlook is dismal as business conditions are challenging, lower demand due to winter weather, and they are also forecasting lower same store sales. This is a problem since they are not opening up new stores but rather closing up their stores, and renovating other ones. • Projected Q1 2014 profit is expected to be breakeven or slightly negative compared to a profit of 18 cents a year ago.
Reformulated Income Statement Adjustment for Operating Lease and Employee Stock Options
Reformulated Balance Sheet (NEA) Breakdown found in footnotes allows for a better projection. This was an operating lease found in the footnotes and was not on the previous balance sheet and needed to be capitalized
Reformulated Balance Sheet (NFL) These two numbers tie out to the 1,400,486 capitalized lease asset under NEA. Also the $1,865 is the liability associated with the stock options that were not on the balance sheet to begin with, but must be accounted for. Employee stock options will increase AEO’s NFL, but decrease their common stockholder’s equity.
Cost of Goods Sold Assumption • Trend Analysis Average was 62.37% • Forecasted Assumption 64% • Basis: • Increase in commodity price such as energy and raw materials • Increase in labor costs
SG&A Assumption • Trend Analysis Average was 23.75% (High of a little over 24% in Fiscal Year 2014). • Forecasted Assumption 23.75% • Basis: • Seems as though most of SG&A is due to performance based awards, and this was something the interim CEO has commented on that in order to incentives management they are moving toward more stock options and restricted stock option units. • This is not a one time thing as after further research I looked at the insider transactions and as of 4/1/2014 six executives were awarded stock options so I think that this number will stay fairly consistent over the next few years as per my forecast.
Common Size Analysis Balance Sheet (NEA) Inventory is what will eventually drive sales (working capital) this reduction signals to me that they are reducing inventory on hand to improve turnover ratio, and to make it seem like they are turning inventory over faster.
Balance Sheet Assumptions • Used a trend analysis average for each of the balance sheet accounts. • Felt as though as a percentage of sales there was not too much deviation year over year and that forecasting out using an average would be the most accurate way to forecast going forward.
Adjustment of NEA • Decided not to increase net enterprise assets nor decrease net enterprise assets significantly. Mainly because of management’s expectations and initiatives for American Eagle going forward. They seem as though they are not looking to expand, but rather focus on particular niche’s in the country. Rather than expanding by adding more property, plant, and equipment, increase inventory, or acquire other companies (pay more than book value creates goodwill; purchase method of accounting) they are simply taking existing assets and consolidating them into fewer stores. So even though they are divesting businesses; one might think to decrease assets but they are taking those assets and putting them into other stores across the United States in stores they targeted as stores that are more likely to produce sales. This is also why I believe the same stores sales growth number is imperative when looking at American Eagle.
Excel Calculation Beta Calculation Formula’s Used
Weighted Average Cost of Capital Original Before Capitalization of Leases
WACC After Capitalizing Leases • American Eagle does not have long term debt so therefore trying to come up with a cost of debt was extremely difficult so I looked at three different options. • Calculate RNFL • Use Revolving Term Loan • Use a Comparable Company
RNFL After tax cost of debt. This seemed to low and would give me too high of a share price that is not accurate based on expectations.
Revolving Credit Loan • American Eagle does not have any debt on their balance sheet but they do have a revolving credit loan. It is calculated by adding LIBOR and other percentage fees associated with the loan. These other percentages were given in ranges and the highest ranges were used in the calculation to the right.
Comparable Company • I looked at Bloomberg and was able to find a credit rating and they were listed as investment grade 8 and ran an analysis of comparable companies within the consumer discretionary industry who also had an investment grade rating of 8. Express Inc. (EXPR) was the closest comparable. None of the companies within my group had issued any long term debt. I looked at the bonds issued at 15+ years and tried to look at ones that did not have any calls or puts attached to them and came up with a yield to maturity of around 10.75%, and a coupon rate of 8.75%.
Abnormal Enterprise Income Growth Valuation Model (New WACC)
Buy, Sell, Hold Recommendation • American Eagle is a Sell. (Current Share Price $11.00) • Although unemployment has been coming down I think this is a fabricated number, and the real number is much higher which helps to explain the lower than expected holiday season. I do not buy the severe weather since majority of people do their shopping online. • I think they will be subject to higher commodity prices in which will reduce their bottom line. • They will not be able to compete with off-price retailers such as Marshalls, TJ Maxx, etc… • I also think that their brand is not as strong as it used to be and that they are becoming a forgotten brand. • The most worrisome part is that their target market is from the ages of 15-25 and most kids do not buy American Eagle; surprisingly many kids spend their money on more “top-tier” brands (i.e. Brooks Brothers, etc..)
The End Any Questions?
