Initiating American Eagle Outfitters

After you receive this Alert, we will be initiating a position in American Eagle Outfitters (AEO) , buying 1,500 shares at roughly $34.48. Following the trade, AEO will represent 1.35% of the portfolio.

We are bringing AEO out of the Bullpen and adding a position to the portfolio as our recent sale of Disney (DIS) has made room for a new name. You can read our initial Bullpen post at the link here. Additionally, you can find the slide deck to the company's 2021 Investor Meeting at the link here.

American Eagle Outfitters is a specialty retailer with two major brands (American Eagle and Aerie) that are currently benefiting from the pent-up demand in denim and people updating their wardrobes to look great in a reopened society.

The American Eagle brand has made a major comeback recently thanks to the industry-wide revival in denim. The American Eagle is number one brand in jeans for women and 15- to 25-year-olds, making the company a clear beneficiary of continued spending on this hot trend.

Meanwhile, Aerie is one of the strongest retail concepts out there and has delivered an impressive 26 consecutive quarters of double-digit growth thanks to its positioning in fast-growing categories such as athleisure wear, loungewear, swimwear and also its Offline sub-brand that launched last year.

The company's first-quarter 2021 results reported in May were exceptional, with total net revenues increasing 17% over 2019 levels to an all-time high first-quarter record of $1.03 billion. In addition to strong sales, American Eagle Outfitters saw a significant increase to profits as well. The company's gross profit of $436 million was a record for the first quarter and represented growth of 34% over 2019 levels.

Additionally, gross margins expanded by a whopping 550 basis over 2019 levels to 42.2% with management citing significantly higher merchandise margins across brands, primarily due to higher full-priced sales, lower promotions, and inventory optimization initiatives as the main drivers for the increase.

Operating income of $133 million was a record for the first quarter too, and this outsized figure put the company on track to achieve its Investor Day 2023 operating income target of $550 million this year.

Although management held back from providing firmer guidance besides the $550 million operating income outlook, we came away from the first-quarter report very encouraged with what management had to say about the future.

On the earnings call, CEO Jay Schottenstein said that he believes the company's "best days are ahead us of. I see great potential. I see great potential in America Eagle by itself. Aerie's on fire." Schottenstein further added that he believes Aerie will reach management's target of $2 billion in sales within the next 12 months, faster than the 2023 target management set at the investor day.

American Eagle Outfitter has had a strong 2021, gaining roughly 72% year to date, and the stock is up more than 400% from its pandemic lows. But even after this major move, we think AEO still has plenty of room to run. AEO has traded roughly sideways since April and is off about 9% from its 52-week high despite signs that consumer spending has picked up.

According to J.P. Morgan's Chase proprietary credit card data, consumer spending reached a new peak of +14% (over pre-pandemic 2019 levels) in the first half of June, an acceleration from the +13% rate in May and +9% in March/April. This is a telling sign that consumers are spending more as they emerge from their homes.

American Eagle Outfitters is also well positioned to capitalize on the multiple catalysts the retail industry is set to go through during the back half of the year. More specifically, in a recent research note that discussed some of his favorite investor themes in retail, J.P. Morgan retail analyst Matthew Boss pointed to a Back-to-School season that could be the biggest in history with only five states in the United States expected to have partial closures in effect for in-personal learning. He also thinks retail spend -- and AEO specifically -- will benefit from the child tax care credit worth $3,600 per child under six years old (or $3,000 per child ages 6-17.) This is a second-half story because the American Rescue Plan Act of 2021 allows parents to receive six monthly advance payments beginning in July. Third, Boss sees the potential for a denim-led fashion cycle.

In addition to the positive earnings story, we like how management is rewarding shareholders by returning excess cash. For example, earlier this month, American Eagle Outfitters announced a 31% increase in the quarterly cash dividend to $0.18 per share. The move was a classic sign of management having confidence in its future outlook. This increase to the dividend put the yield on shares at about 2.17%, which we believe to be is very solid in the current environment. Analysts at Jefferies believe share repurchases could re-enter the picture here as well due to the company's ~$720 million cash position and track record of generating over $200 million in free cash flow annually.

We are initiating the position with a $40 price target, which reflects roughly 17.5x consensus estimated FY 2022 earnings per share.

Action Alerts PLUS, which Cramer co-manages as a charitable trust, has no positions in the stocks mentioned.