American Eagle disappointing 3rd quarter results baked into valuation.

Implications: With American Eagle (AEO) stock price down almost 40% since January the upside should be on the horizon for this down beaten equity. This is a factor of the stock already priced taking into account the poor 3rd quarter results and the pent up demand created by the unusually hot (temperatures at 40 year highs) in the 3rd quarter

Analysis:  

With the assortment geared towards the cooler weather as it should be the forecasted cooler holiday season should facilitate an increase in top line sales. The company did not over react to the tough October by taking deep markdowns so the margins in the core assortment should hold if the weather cools.

AEO does have some other pressing problems: namely, Aerie and Martin + Osa. The former has a very high inventory build right now due to the optimism of the strong top line sales results from its introduction. As Victoria Secret’s Pink holiday assortment targeting the same demographic looks strong Aerie could sustain heavier mark downs than originally planned. The latter has yet to find its niche and is a drag on the company.

AEO, as with most other apparel retailers, had a strong BTS season that gave them confidence in the holiday projections. The inventory is heavy in comparison to the square footage and regardless of how strong the next 9 weeks prove the markdowns will indeed be heavier, cutting right into the margins. The bottom line is that AEO will come no where near their peak operating margins of close to 20% in 2007 (21% in 2006) and this will give a negative vibe to the stock. The street knew that the 20% operating margin was not sustainable but when there is a decline in operating margin the reality becomes compounded.