Learn more about why we bought more of this retailer before the holidays

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On Thursday, June 18, 2020, a shopper wearing a protective mask walked past the sales sign of the American Eagle Outfitters Inc. clothing store in the San Francisco Center in Westfield, San Francisco, California.

Michael Short | Bloomberg | Getty Images

(This article was first sent to members of the CNBC Investment Club with Jim Cramer. To get real-time updates in your inbox, Subscribe here.)

The charitable trust fund holding American Eagle Outfitters (AEO) announced stronger-than-expected third-quarter results on Tuesday morning, and its stock price rose on Tuesday.

Break down the numbers:

Total net income increased by 24% year-on-year to US$1.27 billion, higher than the expected US$1.23 billion (FactSet). According to FactSet’s data, adjusted earnings per share were US$0.76, which was lower than the consensus estimate of US$0.61.

In terms of sales, due to double-digit growth in passenger traffic, general store revenue increased by 29%, while digital revenue increased by 10%, an increase of 29% over the same period last year. Both store and digital revenue and profits in the quarter exceeded the level of the third quarter of 2019, which shows that the company has emerged from the pandemic and is in a strong position.

The rise of casual wear, we believe that this trend will continue for many years and continue to be a huge driving force for the sales growth of the company’s two leading brands.

Highest profit rate in years:

The company’s gross profit margin in the third quarter was the highest since 2007, an increase of 410 basis points year-on-year to 44.3% (1 basis point equals 0.01%). This exceeds the estimate of approximately 42%. This increase is mainly due to the leverage of rents and delivery as well as strong product demand, higher full-price sales, fewer promotions and inventory optimization measures, although higher freight costs are a drag.

The 16.5% operating profit margin is also the highest level since 2007, exceeding expectations of approximately 13.8%. Total operating income for the quarter was 210 million U.S. dollars, a substantial increase from the expected 170 million U.S. dollars. The management stated on the conference call that they expect this year’s operating income to “significantly exceed” $600 million.

Brand breakdown:

  • By brand, Aerie’s revenue increased by 28% year-on-year to US$315 million. The momentum here is unstoppable, and the quarterly performance represents the 28th consecutive quarter of double-digit growth. The company cited the strong demand for the entire Aerie product portfolio, among which the strength of underwear and offline sportswear is significant. Aerie also seems to be grabbing market share because management stated that they see customers have higher transaction frequency and involve more categories. Due to higher full-price sales and strategic decisions around promotion, AUR or average unit retail (average selling price) increases in the teens. Aerie’s operating profit margin was 16.5%, an increase of 200 basis points from 2020, setting a new high for the brand in the third quarter. Aerie overcomes the challenges associated with the imbalance of inventory flows associated with the shutdown of the southern Vietnam factory. These shutdowns mainly affected Aerie’s high-demand leggings business, which is also a high-margin category. Therefore, if Aerie does not miss certain businesses, their profit margins will be higher.
  • American Eagle’s revenue increased 21% year-on-year to US$941 million. The growth in sales this quarter was driven by growth in all categories of menswear, while womenswear achieved strong results, partly because of its iconic denim category. Thanks to the brand’s leading position in the jeans field and new product styles, American Eagle also ushered in a very strong back-to-school season. When you hear about the beneficiaries of the denim cycle, you must include American Eagle because the company ranks number one among women’s denim of all ages and number one among men’s denim of its age.

We have also seen signs that the American Eagle is not a market share donor as some people think. The company said on the conference call that its customer profile has been established and that customers’ purchase frequency and expenditures are also higher. Due to inventory optimization and promotional discipline, AUR increased and product profit margins expanded. The operating profit margin for the quarter was 27.8%, setting a brand new high.

Key theme-inventory and supply chain:

American Eagle Outfitters’ ending inventory costs increased by 32% to US$740 million. The company said that this increase was partly due to an increase in air freight due to disruptions in the global supply chain, resulting in an uneven flow of inventory related to the closure of the Vietnamese factory. In order to ensure that their store has sufficient inventory during the holidays, the company chose to ship the product by air. Taking all factors into consideration, management is satisfied with their inventory before the supposedly strong holiday.

Renewing everyone’s favorite supply chain and logistics topics, the company continues to effectively manage this challenging environment with almost no interruption beyond the closure of the Vietnamese factory. Due to the increased efficiency of digital delivery, the delivery cost of AEO actually decreased year-on-year. That being said, the company expects to incur between 70 million and 80 million U.S. dollars in freight costs in the fourth quarter.

The management also spent some time on the conference call to discuss its recent acquisition of Quiet Logistics. During the conference call, Chief Operating Officer Michael Rempell stated that this transaction allows AEO to “significantly increase sales and profit margins with less inventory, make our inventory allocation decisions more precise, and Deliver products to customers at a faster speed and lower cost.”

This transaction was carried out after the acquisition of AirTerra. During the conference call, CEO Jay Schottenstein said: “We hope that Quiet Logistics, combined with the recent acquisition of AirTerra, will create a unique platform that will revolutionize logistics in our retail business.”

Sufficient firepower:

Regarding cash, the company had $741 million in cash on its balance sheet at the end of the quarter. Thanks to a strong balance sheet, American Eagle Outfitters has sufficient firepower to support investments in growth plans and shareholder returns. At current levels, we find a 2.5% dividend yield attractive. In view of cash flow, we do not rule out the possibility of future share repurchase activities.

Bottom line:

Overall, it was an amazing quarter for American Eagle Outfitters because the company proved to be one of the big winners of the back-to-school shopping season we initially thought. With its brand’s momentum in the development of casual wear and sportswear and the highest level of profitability in more than a decade, we believe that American Eagle Outfitters is ready to launch this holiday season.

Earlier, we were confused about how the stock did not receive any praise in the market due to this strong report, which explains why we decided to increase our holdings this morning.

It is clear from this quarter that American Eagle Outfitters has emerged from the pandemic to become a better company with the correct product classification and exciting new logistics plans. We believe that this cheap stock that trades at a low teenage P/E ratio and a 2.5% dividend yield is going higher.

The CNBC Investment Club is now the official location of my charitable trust. Here, you can see every move we do for the portfolio and gain my market insight before anyone else. The Charitable Trust and my work are no longer affiliated with Action Alerts Plus in any way.

As a subscriber to the CNBC Investment Club with Jim Cramer, you will receive transaction reminders before Jim makes a transaction. Normally, Jim waits 45 minutes after sending a transaction alert before buying or selling the stocks in his charitable trust portfolio. If the trade alert is sent before the market opens, Jim will wait 5 minutes after the market opens before executing the trade. If the trading alarm is issued for less than 45 minutes during the trading day, Jim will execute the trade 5 minutes before the market closes. If Jim talked about a stock on CNBC TV, he would wait 72 hours after issuing a trade alert before executing the trade. Please see here for the investment disclaimer.

(Jim Kramer’s charitable trust is a long-term AEO.)

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