American Eagle downgraded at Standpoint Research

Standpoint Research has downgraded American Eagle Outfitters (AEO) to hold from buy, expressing concerns over the apparel retailer's store count.

Pittsburgh, Pennsylvania-based American Eagle has a market cap of about $3.3 billion and is struggling to grow its store count and revenues.

When we value retailers we are more concerned with what the store count will be a few years from now as opposed to betting on Thanksgiving Day, weekly, monthly or quarterly comp store sales figures. The store count at AEO is now at about 1100 versus about 1000 three years ago and about 800 seven years ago. Revenues are at $3 billion, up just 7 percent versus 2006, analyst Ronnie Moas wrote in a note to clients.

Meanwhile, on the valuation perspective, Moas said the company's shares have gained 40 percent since August 12 and is fairly valued at 9 times peak earnings from 2006-2008, 18 times trailing twelve months earnings and 15 times (rising) estimates for next year.

The shares have out-performed the S&P-500 by more than 2000 basis points since mid-August and will be challenged to out-perform the Index going forward, Moas added.

The company is set to provide its fourth-quarter earnings outlook on Dec. 2, 2010 along with its November sales announcement. On Nov.18, American Eagle reported quarterly earnings of 29 cents a share, in line with Street, and generated revenue of $751.5 million, better than Wall Street's estimate of $748.8 million.

However, Moas noted that his downgrade should not be seen as a bearish forecast on the company's outlook and he thinks the good news is already priced in the stock.

We still see $4 in upside in American Eagle over the next 12-24 months, but there is also $4 of downside risk; we usually look for this ratio to be at least 2:1. We are now looking for a name to replace AEO with that has a more favorable risk-reward and valuation, the analyst said.

If we look out 18-36 months, AEO could earn $1.50-$2.00. Unfortunately, in our opinion, the market will not attach multiples to these earnings in the future as it did in 2006-2008 at 18 times when the AEO share price topped $30 and was growing aggressively, Moas added.

The analyst also said the company's average weekly inventory per square foot is down to mid-single digits, resulting in lower markdowns and stable margins.

If AEO corrected to < $15 we would consider reinstating this recommendation, Moas said.

Shares of American Eagle Outfitters closed Tuesday's regular trading session at $16.50 on the NYSE.

Meanwhile, Moas also noted that his downgrade has nothing to do with the ongoing rise in the cotton prices. Moas said cotton prices have more than tripled to $1.12 per pound since the February 2009 low due to the weather storm in Texas and cooler temperatures in China.

That being said, the price is at or below prior price spike levels (1995 & 1998) on an inflation-adjusted basis and 40 percent to 50 percent above where it was in 2004, 2008 and most recently in the second quarter 2010.

Additionally, cotton demand has been outstripping supply in part due to demand from emerging markets. U.S. farmers have moved away from cotton and into more profitable crops and India have also restricted exports of the fiber in order to maintain prices domestically.