AEO Lifted to Outperform

We upgraded our long-term recommendation on American Eagle Outfitters Inc. (AEO - Analyst Report) to Outperform based on the company’s robust first-quarter 2012 earnings and fiscal year 2012 guidance.

Driven by solid top-line performance along with improved operating margin, American Eagle’s adjusted earnings of $0.22 per share for first-quarter 2012 climbed 37.5% from the prior-year period earnings of $0.16, handily beating the Zacks Consensus Estimate of $0.20. Moreover, during the quarter, American Eagle’s adjusted net sales went up 18% year over year to $708.7 million, primarily driven by a 17% rise in comparable store sales.

Looking ahead into fiscal 2012, the company expects adjusted earnings to be between $1.16 and $1.22 per share, an increase of 19% - 26% from the previous fiscal adjusted earnings of $0.97 per share on the back of mid-single-digit growth in comparable store sales. However, for second-quarter 2012, the company expects earnings in the range of $0.13 to $0.15 per share compared with $0.13 per share in the prior-year period.

Further, we remain impressed with the company’s continued momentum in denim along with improved merchandise assortments in the women’s business segment, which will likely augment its top-line performance as well as enhance gross margin.

American Eagle now plans to focus more on merchandise assortments, adding more compelling brands, managing inventory level much diligently and augmenting e-commerce business. Moreover, it remains committed to enhance store sales productivity by closing underperforming stores. Further, in order to emphasize more on core business while generating the best possible return for shareholders, American Eagle has decided to exit from its children s brand, 77Kids.

Moreover, we believe American Eagle’s cost-saving initiatives and long-term growth strategy will not only provide financial flexibility, but will also help to drive value proposition. In a drive to boost its bottom line, the company is relentlessly focusing on initiatives to cut down costs through supply chain efficiencies and updated product allocation system. On the other hand, the company’s long-term growth strategies remain hooked to opening stores in the Middle East and developing economies like India and China.

Nevertheless, operating in the highly fragmented specialty retail sector, American Eagle faces intense competition from other teen-focused retailers, such as Abercrombie & Fitch Co. (ANF - Analyst Report) and Gap Inc. (GPS - Analyst Report). Currently, the company carries Zacks #1 Rank, which translates into a short-term ‘Strong Buy’ rating, in sync with our long-term Outperform recommendation.