Friday, June 11, 2010

American Eagle Outfitters (NYSE:AEO) : Time To Close Eyes Again, and Buy Shares, Upgrading to Buy -Jefferies

Jefferies' Specialty Retail team is upgrading American Eagle Outfitters (NYSE:AEO) to Buy from Hold while raising their price target to $18 (prev. $15). Firm sees favorable upside/downside near +50% / -10%.

- Stepping Up To The Plate Again. In 2009 Jeffco notes they had a BUY call on AEO to reflect cheap valuation, fundies turning off a bottom and a still relevant brand. That call worked with shares up 80% LY. Then on 1/4/10, they downgraded to HOLD citing ambitious turnaround expectations by the market. Since then shares are down 30%. They now think bad news is priced in, earnings estimates are low enough and sentiment is too negative so they are upgrading back to BUY.

How It Plays Out. While 2Q results will be punk, it's already in the guidance, Street estimates and the stock. Inventory will be down by 3Q which should aid margins in 2H. Jeffco also believes cost cutting is coming in a big way, which will further aid margins. With earnings forecasts cut by the sell-side over the past several months, they think the negative earnings revision cycle is near an end which should move the stock off the lows.

Multiple Catalysts Ahead. They see many catalysts to lift AEO shares: 1) Inventories lowered to drive margin stability in 2H, 2) New design leadership having impact on 2H deliveries, 3) Potential comprehensive cost cutting program could be announced (signaled on 1Q CC), 4) Stock buybacks will likely accelerate further, 5) Potential special dividend or more dividend increases could be on table, and 6) Look for a largely neutral rated sell-side community to possibly upgrade shares later this year.

Finally Valuation Is Too Too Cheap To Ignore. Here are the stats: 1) Near 30% of market cap in cash, 2) P/E just above 10x on depressed earnings, 3) EV/EBITDA under 4x, 4) div yield near 3.5%, 5) FCF Yield near 10%. This puts valuation at one of cheapest in all of retail for a company with a real brand, real cash flow generation and really big cash war chest.

Jeffco has included some incredibly appetizing comments in their call:

1) EPS Estimates Have Been Cut

Street Estimates Revised Down To Prior Levels

Street estimates are back down after a rise in expectations earlier in the year. While earnings cuts are not severe at first blush, Jeffco notes the cuts are significant as earnings estimates have been on the rise at peer companies.

2) Cash Is King…Don’t Forget That:

Share repos likely accelerate. Company has repurchased nearly 6M shares YTD and has 24M (~11% of shares out) left under current authorization.

Dividends likely increase. On 6/9/10 company raised the dividend by 10% making the div yield near 3.5% or one of the highest in retail.

Jeffco notes they wouldn’t rule out a special dividend in the future too. Companies like HOTT (NR), LTD (rated Hold) and BKE (NR) announced special dividends in the last 12 months to deploy excess cash to shareholders.

With a near 10% FCF yield, they believe AEO will generate plenty of excess cash to disperse to shareholders.

3) Valuation is low

EV/EBITDA at ~3.5x is the lowest in retail on highly depressed fundamentals. If the stock price was to fall by 10% (Jeffco's downside case), EV/EBITDA would be close to eclipsing 3x cash flow.

In this sector, EV/EBITDA valuations usually bottom around 3x, are normalized around 6-7x and are high >10x. Based on these current valuations,they wouldn’t be surprised to see private equity entities take a look or activist investors begin to shake the trees.

Notablecalls: Ok, I have some comments on this one, both good & bad.

The bad:

- Jeffco's Randy Konik is the same analyst that made the uber-bullish & apparently uber ill-timed call on Abercrombie & Fitch (NYSE:ANF) back in April. Good thing he wasn't alone in this mess. Both Credit Suisse & Mrogan Stanley came out with positive comments soon after and sent their clients to the slaughterhouse (see archives for more colour).

- Reading the call, Konik is trying to leave us with the impression he upgraded AEO in 2009, giving his clients a 80%+ ride.

I'm sorry Randy for bringing this up, but you had a buy on AEO ever since 2008 (or maybe even longer). You rode the stock down from high $20's in 2007-2008 all the way to $7-8 in 2009. Your low target was $12 in 2009.

The good:

- AEO is cheap.

A week ago I spoke to a new NCN (Notable Calls Network) member that advises several hedge funds and he was getting bullish on AEO.

'These things tend to bottom out around 3x EV/EBITDA. It's almost impossible for these type of co's to go out of business if there is no excessive leverage. They reinvent themselves and you will get very nice returns buying at around current valuation. This is what the stupid long-only guys watch all day'

- Konik actually makes a fairly good case in AEO. The thing is cheap & has catalysts.

So, I think AEO has a good chance of trading up by 5-8% today, putting 13.50+ levels in play.

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