American Eagle Outfitters is a clothing company headquartered in Pittsburg, Pennsylvania. The company operates both online and offline, with 933 stores as of February 3, 2018. American Eagle Outfitters also includes the Aerie Brand, Tailgate, and Todd Snyder, which add 114 operating stores to the figure. The brand has 214 licensed stores in various parts of the world, including Israel, Japan, and Saudi Arabia. The company’s revenues have been steadily growing in the past four years, which might indicate a good investment opportunity. The present paper will perform a comprehensive financial statement analysis in order to evaluate the prospective risks and benefits of investing in American Eagle Outfitters (AEO).
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As part of the comprehensive financial statement analysis, ratios of activity, liquidity, solvency, and profitability were evaluated (Table 1). Firstly, the company’s inventory turnover was 6.09 in 2017, which is a decrease of 1.54 compared to the 2014 figure. Although AEO’s results are still above the industry average, there has been a reduction in the effectiveness of inventory management in the past few years. However, the second activity ratio that was calculated as part of the analysis showed some improvement. In 2017, the company’s total asset turnover was 2.09, compared to the 2014 figure of 1.93. The results show that the company manages its inventory and assets more effectively than most other clothing retailers.
Secondly, the company’s current and quick ratios were analyzed to evaluate liquidity. Current ratio reflects the company’s ability to cover its current liabilities with current assets, whereas the quick ratio shows whether or not the company can cover its current liabilities without selling the inventory (Robinson, Henry, Pirie, & Broihahn, 2015). Thus, the quick ratio accounts for the possibility of devaluation of the inventory. The company’s current ratio in 2017 was 2.00 and has been steadily increasing in the past three years. Similarly, the company’s quick ratio of 1.01 shows that the company would be able to cover all of its current liabilities without relying on the inventory. Both ratios indicate good overall liquidity, while the fact that they are improving over time suggests that the company grows its assets while maintaining its liabilities at the lower level.
Debt-to-asset ratio was used to assess the company’s solvency. This ratio shows the share of the company’s assets that are financed with debt (Robinson et al., 2015). High debt-to-asset ratio means an increased financial risk and impaired solvency. AEO had a debt-to-asset ratio of 0.31 in 2017, which means that 31% of the company’s assets were financed by debt. This result is rather positive, as it means that the company does not face any serious financial risks at the moment. More importantly, the ratio has been decreasing over the past four years, which suggests that the company takes steps to facilitate effective asset management and minimize its liabilities.
Finally, gross profit margin and return on assets were calculated to examine profitability. AEO’s gross profit margin was 36% in 2017 and remained rather stable throughout the years. However, the company’s return on assets, although it grew from 0.05 in 2014, has been declining slightly in the past 3 years. This could be due to the company growing its assets and buying new property to open new stores. Nevertheless, am 11% return on assets is relatively high for the clothing industry sector and distinguishes American Eagle from its competitors. For instance, Abercrombie & Fitch Co. (2018), which operates in the same industry sector, had an ROA of 0.3% in 2017. Thus, the company’s profitability is high comparing to its competition.
Table 1. Financial Ratios.
|Total asset turnover||2.09||2.02||2.18||1.93|
|Profitability||Gross profit margin||0.36||0.38||0.37||0.35|
|Return on assets||0.11||0.12||0.14||0.05|
Business Model and Strategy
The company’s business model is similar to those of other clothing retail brands, as AEO generates profits from company-owned stores, licensed stores, and online sales. The company is working to expand its global reach by opening stores in new locations, thus entering new geographical markets (American Eagle Outfitters, Inc., 2018). The company’s target market includes school and college students, as well as people who like casual clothing. AEO has good quality standards but chooses to stay in the cheaper price range in order to remain affordable for its target customers.
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American Eagle’s strategy prioritizes market leadership and expansion to new markets, with 31 new stores opened by the company in 2017. However, rather than increasing the total number of stores, AEO analyses its store portfolio to close inefficient stores, which enables the company to maintain a high ROA. The company is also concerned with developing the Aerie Brand and has opened seven new mono-brand stores in the United States and Canada in 2017. AEO’s main strategy is to earn market leadership by delivering value and quality to customers.
Projected Net Income and Cash Flow
The projections for net income and cash flow were made based on 2017 figures, as well as the following list of assumptions:
- Annual sales growth will be 5%
- Cost of sales will remain at 64%
- Operating expenses will stay at 30%
- Interest income rate will be 2%
- The tax rate will be at 30%
- Working capital will be 13% of sales
- Adjustments of net income will be at 90%
- Financing of operations will be at 80%
- There are no significant year-to-year currency fluctuations
Table 2 provides the projected figures of net income and cash flow. Projections of net income were made based on sales, cost of sales, operating expenses, interest income, and taxes. Cash flows projections included the figures that are part of the company’s statements of cash flows in order to ensure clarity and accuracy.
Table 2. Projected Net Income and Cash Flows.
|Cost of sales||2,425,044||2,550,609||2,678,139||2,812,046||2,952,649||3,100,281|
|Income before tax||287,173||246,692||251,076||263,629||276,811||290,651|
|Net cash from operations||394,463||342,487||349,649||372,002||394,736||418,966|
|Less: Investment in fixed capital||-172,150||144,205||147,221||156,633||166,205||176,407|
|Less: Financing of operations||-188,772||-337,836||-359,971||-375,406||-392,001||-409,236|
|Exchange of cash||1,496||–||–||–||–||–|
|Change in cash||118,546||148,857||136,899||153,229||168,939||186,137|
Conclusion: Investing in American Eagle Outfitters
Overall, the current financial performance of American Eagle Outfitters is promising. The company’s sales are growing each year, and the key ratios related to profitability and liquidity are thus increasing. The company has no liquidity or solvency problems, which means that the financial risk of the investment is rather low. Also, AEO’s strategy has already helped it to outperform some of its key competitors, and there is a high chance of positive future development. Therefore, the company appears to be a beneficial candidate for investment, and I would invest my $100,000 into American Eagle Outfitters.
Abercrombie & Fitch Co. (2018). Annual report 2017. Web.
American Eagle Outfitters, Inc. (2018). Form 10-K. Web.
Robinson, T. R., Henry, E., Pirie, W. L., & Broihahn, M. A. (2015). International financial statement analysis (3rd ed.). Hoboken, NJ: John Wiley & Sons.