Home > Long Ideas, Short Ideas > American Eagle & Ralph Lauren: Buy Cheap, Sell Dear

American Eagle & Ralph Lauren: Buy Cheap, Sell Dear

 

Introduction

Both American Eagle (NYSE:AEO) and Ralph Lauren (NYSE:RL) are in the apparel and accessories businesses. Descriptions of the companies are as follows:

 

AE Description Excerpt from Google:

American Eagle Outfitters, Inc. is an apparel and accessories retailer that operates more than 1,000 retail stores in the United States and Canada, and online at ae.com. Through its family of brands, American Eagle Outfitters, Inc., offers clothing, accessories and personal care products.

 

RL Description Excerpt from Google:

Ralph Lauren Corporation, formerly Polo Ralph Lauren Corporation, is engaged in the design, marketing and distribution of products, including men’s, women’s and children’s apparel, accessories (including footwear), fragrances and home furnishings. The Company operates in three segments: Wholesale, Retail and Licensing. Its apparel products include a range of men’s, women’s and children’s clothing. Accessories include a range of footwear, eyewear, watches, jewelry, hats, belts and leathergoods, including handbags and luggage.

 

Analysis

Before getting started, it is worthwhile to point out that both AE and RL are profitable companies with solid balance sheets. The potential opportunities described in this article have seemingly arisen because one company appears over-appreciated and the other under-appreciated. Since nothing extraordinary in either cash flow statement or balance sheet was detected, the analysis will focus on earnings.

 

wikinvest.com data extends back ten years for RL but only seven for AE. This difference does not affect the conclusion but is worth mentioning.

 

AE Income Statement from wikinvest.com:

 

RL Income Statement from wikinvest.com:

 

RL has clearly experienced more sales and earnings growth than AE. One factor explaining this difference relates to sales geography. RL currently generates roughly 1/3 of its sales outside of the US whereas AE generates only 10% of its sales outside of the US. It seems likely that US consumer demand will remain tame (at best). However, will international sales growth continue? With 20% of RL sales coming from Europe and 10% coming from Asia, it seems likely that RL will not escape the ongoing economic malaise unscathed.

 

Valuation

As stated previously, AE and RL are both in fine shape financially. However, the value of an investment rests upon the price paid for it. If the price is low enough, then almost any asset can be a good investment. The converse is also true.

 

In this case, AE appears cheap and RL appears expensive. Although they serve different markets, they share many of the same underlying fundamentals.

 

In 2010 AE earned $182M after tax from continuing operations and today (September 14, 2011) the market value of AE is $2.13B. This means that if AE continues along without any growth, then investors will be earning ($182M / $2.13B) 8.5% annually on their investment. Of those earnings, roughly half will be paid out as dividends that translate into a 4% dividend yield using today’s $11 stock price. Under these assumptions, AE looks cheap.

 

In 2010 RL earned $568M after tax from continuing operations and today (September 14, 2011) the market value of RL is $13.24B. This means that if RL continues along without any growth, then investors will be earning ($568M / $13.24B) 4.3% annually on their investment. Of those earnings, roughly 13.5% will be paid out as dividends that translate into a 0.56% dividend yield using today’s $143 stock price. Since RL will almost certainly experience some growth, let us assume that RL’s 2011 earnings will increase by 10% and will continue increasing at 10% for the next decade before slowing down to a modest 3% per year growth rate. Under these assumptions, RL looks reasonably priced. However, without a decade of 10% annual growth, RL looks expensive.

 

Additionally, here is a table with other relevant valuation metrics using the trailing twelve months (TTM) of data:

Valuation Metrics
(Based on TTM of Data)
  Price/Sales Price/Earnings Price/Book
AE
0.7
12.9
1.6
RL
2.2
22.2
4.2

 

Conclusion

Individually, a long investment in American Eagle or a short investment in Ralph Lauren is interesting. However, combining both is even more interesting since some of the market forces applicable to the retail and accessories industry would be eliminated. If both AE and RL move towards their long-run price/sales ratio of around 1.4x, then a long investment in AE has considerable upside potential as does a short investment in RL. The international growth story and the notion of resilience in the upper end of the retail market are supporting RL. If either of these components disappoint, then RL earnings and its share price will likely follow. As for AE, considerable pessimism is already included in its share price. Overall, if things improve, AE should do well, but, if things do not improve, then RL should do worse than AE.

 

Disclosure: Long AEO, Short RL.

 

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Categories: Long Ideas, Short Ideas
  1. October 13, 2011 at 1:14 am

    I think this is one of the most significant info for me. And i’m glad reading your article. But should remark on few general things, The website style is perfect, the articles is really great : D. Good job, cheers

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