In the recent months, the US retail sector has taken a big beating with many stocks trading in the value category. In this section, we will take a look at American Eagle ( AEO ) Outfitters and see the prospects.
First some basics on American Eagle. American Eagle Outfitters, Inc., a retailing company, engages in the design, marketing, and sale of clothing in the United States and Canada.The comapny has been growing fast with 20%+ growth in the past several years. The company's growth has slowed in this year to ~17% rate. The company also hasnt met the analyst's expectation of 5.8% growth in same store sales in the month of May. The company's sales came in at 5% instead. This coupled with the expectation of a recession/high interest rates has caused almost all the retail stocks in the US to become bargains. The list includes companies such as JCP, WMT, ANF and JOSB.
AEO is particularly attractive compared to this group as it carries zero debt on its balance sheet and its growth rate is still in the double digits. The company has about half a billion dollars of cash on the balance sheet and is buying back about 15 million shares. This should reduce the number of outstanding shares by 7-8% and boost the EPS by 7.5 - 8.5%.
Let us do the discounted cash flow analysis for AEO for the next five years. In the fiscal year ending in Feb, 2007, the company had cash flows from operating activities of 750 million and a free cash flow of 525 million. The company has a current market cap 5.75 billion. Assuming conservative growth rates of 15%, 12%, 10%, 8% and 6% for the next five years and a terminal value of 10 billion for the enterprise.
Adding the DCFs, the value looks as follows with a discount rate of 10%.
terminal value 6.2 billion
This yields a value of 8.9 billion for the enterprise without even considering share buy backs. This is a premium of 56% from the current prices for this stock.
To quote Mohnish Pabrai - this looks like a classic situation of "Heads I win, tails I dont lose much!". While the entire sector is battered, AEO seems like an opportunity that is hard to pass up.