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American Eagle Trims Outlook

Investors look past better second-quarter profits and are spooked by inventory levels, sending the stock down to a two-year low.

American Eagle Outfitters Inc.’s second-quarter profits doubled but fell short of projections, and an increase in inventories — some of which was tied to an expansion of the retailer’s accessories business — spooked investors and sent the stock down to a two-year low.

This story first appeared in the August 25, 2011 issue of WWD.  Subscribe Today.

Net income rose to $19.7 million, or 10 cents a share, from $9.7 million, or 5 cents, a year earlier. Still, profits fell 1 cent shy of analyst expectations. Sales for the three months ended July 30 rose 3.7 percent to $675.7 million from $651.5 million, and comparable-store sales were flat.

The company’s stock fell 8.8 percent to $10.60. In midday trading, the stock fell as low as $10.01 — a level not seen since March 2009.

American Eagle also cut its profit outlook for the full year to 85 cents to 95 cents a diluted share. In May, the firm said earnings would be “similar” to last year’s take from continuing operations of $1.02.

“There is no doubt you would have liked [us] to have achieved stronger financial results,” Roger Markfield, vice chairman and executive creative director, told analysts on a conference call. “But we held our own in a highly competitive and promotional environment. I was pleased to see second-quarter sales improve nicely from the first quarter as we began to transition toward a more comprehensive key item strategy in stronger fashion content.”

Analysts zeroed in on inventories, which grew 30 percent on a cost per square foot basis and 15 percent on a unit per square foot basis compared with a year earlier. The inventory buildup reflected the move to a year-round key item strategy and the planned addition of another 150 accessories shops in American Eagle stores by Christmas, bringing the total number of the shop-in-shops to 400.

“We do not view [second-quarter] results and the revised outlook as that bad, given the recent struggles here,” said Jefferies analyst Randal Konik in a research note. “However, we are disappointed with the lack of inventory control, especially in the current uncertain environment. Until management can properly contain inventory, we see no reason to buy this stock.”

Some of the increase in the cost of the company’s inventory came from higher cotton prices, an expense that has eased some lately.

“Higher cotton prices pressured margins and will continue to do so in the second half of the year,” said James O’Donnell, chief executive officer. “There are several indications that the cost of cotton is stabilizing. If that’s the case, there is opportunity to recoup a good portion of the margin that we lost.”

American Eagle is looking for a successor to O’Donnell, who in March said he would retire.

And the company has been repeatedly called out as a possible target for a leveraged buyout.

“[American Eagle] has many characteristics that make it a potentially attractive LBO target, including a clean balance sheet with ample cash and no debt, strong free cash flow, attractive valuation on depressed margins and potential for change from new leadership,” said Adrienne Tennant, an analyst at Janney Capital Markets. “In addition, potential new management could institute positive changes.”