The COVID-19 pandemic accelerated e-commerce adoption while wiping out many of the retail businesses that struggled to adapt. American Eagle Outfitters (AEO +1.38%), however, is in a position to survive and ultimately thrive for three reasons.
1. Online success
Prior to the pandemic, American Eagle Outfitters already had the systems and logistics in place to deliver products straight to shoppers' doors -- a division it dubbed AEO Direct. Its digital sales accounted for 29% of overall revenue in 2019.Having a successful online business already in place entering the pandemic allowed customers easy access to American Eagle Outfitters' various apparel brands without having to venture into a retail store. This was made clear in its most recent quarter, as in-person sales fell 16% year-over-year, but overall sales were buoyed by online strength, only dropping 3%.
American Eagle Outfitters had an even easier time transitioning to online sales thanks to the age demographic of its target customer. Its two primary brands, American Eagle and Aerie, both target high school and university-age students ages 13-29 -- a demographic group that's also the most active on social media. As stores began shutting down and customers stayed home, these customers were still able to connect and interact with the American Eagle and Aerie brands. American Eagle Outfitters Chief Creative Officer Jennifer Foyle even commented on its social media initiatives in its latest conference call, stating that TikTok fuels demand for the Aerie brand.
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2. Outlasting the competition
With shutdowns across the country staying in place, malls continue to see less foot traffic. As most investors know, physical retail locations are highly cost-intensive and rely on a certain number of sales in order to be financially viable. Each physical location has rent, employees, and inventory that it's responsible for. As many brick-and-mortar stores have seen less traffic over the last year, they have also seen fewer profits. Brooks Brothers, J. Crew, and JCPenney are just three examples of traditional retail businesses that took steps toward filing for bankruptcy since the pandemic started.
American Eagle Outfitters wasn't exempt from financial struggles, either. It even went as far as to raise $415 million through a convertible note offering in April of 2020. This debt is allowed to be converted into stock after April 17, 2023 if the shares are worth more than $8.75. Shares currently trade at around $20, so shareholders should expect the share count to rise by about 9% if the company's share price doesn't plunge sharply within the next two years.
While this move looks somewhat desperate in hindsight, it's worth noting that at the time, American Eagle Outfitters had just suffered a 38% decline in quarterly revenue, had a $257 million net loss, and was burning through cash at an alarming rate. This liquidity helped bolster its balance sheet and buy time for recovery.
Shareholders can now breathe a sigh of relief: The company has nearly $700 million in cash and cash equivalents, and it's once again generating positive free cash flow. Unlike most of its competitors, it looks like American Eagle Outfitters is out of the woods. While management hasn't announced anything concrete on paying down this debt early, it did restart its cash dividend payout to shareholders sooner than expected thanks to its "strong financial condition."
3. Hybrid model
The market gives most e-commerce companies premium valuations in relation to their brick-and-mortar peers, but it seems investors might be underestimating the benefits of a hybrid model. Digital-only companies can struggle to create brand relevance in an ever-competitive industry, while physical-only locations have a hard time adapting to increasingly digital-first customers. American Eagle boasts the strengths of both models and the weaknesses of neither, combining traditional in-store shopping at its more than 1,300 worldwide locations with in-store and curbside pickup and AEO Direct.
Having physical locations close to customers' homes gives many businesses a logistical leg up in delivery times over digital-only competitors. In fact, American Eagle Outfitters introduced four new distribution hubs this quarter to help speed up customer delivery and allow stores to operate with less inventory. Real-world locations provide customers with physical touchpoints for better customer service. Supplementally, shoppers also tend to have more trust for brands they recognize, and physical retail locations help build that trust. As proof of this, even Amazon, the most digital-native commerce company of all has introduced more than 60 physical locations across the US, excluding its Whole Foods acquisition.
Surviving difficult times has left American Eagle Outfitters in a position of strength. With its current liquidity, the retailer looks like it's taking this time to focus on what's working and eliminate what's not. Management mentioned on the conference call that it's reevaluating its store count, and even plans to close 50 locations this year alone. Given its strong position within the retail space and its current valuation of about 20 times its normal annual earnings, American Eagle Outfitters looks poised to generate great shareholder returns moving forward.
