American Eagle's stock is poised to soar

By Robert Walberg

Here's a case where a company's stock price masks a screaming buy.

You might think there was trouble brewing for American Eagle Outfitters (AEOS, news, msgs) as the share price tumbled 4% on heavy volume today (before recovering some to close at about $29). But the only trouble I can see is in the minds of traders who dump a stock merely at the possibility of slightly lower earnings in the current quarter.

American Eagle earned $150.2 million, or 66 cents per share, in its fourth quarter -- a year-over-year improvement of 50%. Total sales jumped 27%, with same-store sales increasing by an impressive 14%. There isn't an apparel retailer around that wouldn't kill for numbers like those.

Unfortunately, Wall Street had expected American Eagle to follow up its brilliant fourth quarter with a strong first quarter. When management forecast earnings of 31 to 33 cents, 2 cents below Wall Street estimates, investors headed for the exits.

Over-delivering with results

Yet given difficult industry conditions and uncertainty over consumer spending amid the meltdown in the housing market and turbulence in stocks, management actually deserves credit for adopting a cautious stand. It's better to underpromise and over-deliver than the other way around, and American Eagle has been delivering quarter after quarter for several years.

The company is also spot on with current fashion trends. Colors are bright, pricing is affordable, and the brand still resonates with its teen-to-early-30s market. American Eagle, alongside Abercrombie & Fitch (ANF, news, msgs), is a brand of choice among the younger set.

More importantly, American Eagle has identified a key growth driver for revenue with its new intimates chain called aerie. The original test sites have done very well, easily surpassing company targets, and plans call for 15 new stores in the current fiscal year. If sales remain brisk -- and there's no reason to expect otherwise given the tremendous business done by Victoria's Secret and the lack of any other meaningful competition -- American Eagle hopes to open more than 300 stores within the next five years. That will help drive top- and bottom-line results for many quarters to come.

Less exciting is the company's new Martin + Osa chain, which is designed to appeal to a slightly older crowd. Companies get into trouble when they move away from their core market and start to expand the brand into unproven areas -- an obvious example is The Gap (GPS, news, msgs). Given American Eagle's success to date, management deserves the benefit of the doubt, but investors will want to watch the numbers coming out of the Martin + Osa concept closely. If there's going to be a drag on future results, my guess is this will be it. American Eagle plans to open 12 new Martin + Osa stores this year.

A more attractive value

Capital expenditures are up due to the aggressive expansion efforts, but American Eagle continues to do an excellent job of managing its growth, with gross and operating margins higher again in the most recent quarter. Meanwhile, inventory management remains solid and should improve based on recent technology expenditures.

American Eagle is one of the top plays in the specialty apparel sector, and with today's decline investors can buy the stock at the bargain price of 15 times forward earnings. That equates to one times estimated long-term growth of 15%, well below the industry average of 1.25 times, despite the fact that American Eagle routinely reports superior growth. The valuation gets even more attractive when you consider that the company is sitting on nearly $3 per share in cash and short-term investments (minus debt).

Though it might take a couple of months for the stock to right itself, especially if the overall market remains jittery, American Eagle is a screaming buy at these levels for growth-oriented investors. My upside target over the next nine to 12 months is $36 to $38.

As of tomorrow's open, I'll replace Wal-Mart Stores (WMT, news, msgs) with American Eagle in my Street Patrol tracking portfolio in MSN Money's Expert Picks section. By the way, American Eagle will move to the New York Stock Exchange on Thursday under the symbol AEO.

At the time of publication, Robert Walberg did not own or control shares of any company mentioned in this article.