Staples and American Eagle: Retail Rebounds?

05/31/2017 2:52 am EST

Focus: CONSUMER

Jason Clark

Contributing Editor, The Prudent Speculator

Jason Clark, contributing editor to The Prudent Speculator continues to see value in the retail sector. Here, he looks at an office supply chain and an apparel retailer. that have both suffered from industry headwinds.

Office supply chain Staples (SPLS) earned $0.17 per share in fiscal Q1 2018 (matching the analyst consensus estimate.). SPLS had sales of $4.1 billion, versus the $4.5 billion estimate.

An increased product margin average and a disciplined promotional strategy helped boost earnings, while overall sales declined 3% year-over-year and the company had higher fixed expenses in the North America Retail segment. Shares tumbled 3.5% following the announcement.

For the upcoming quarter, Staples expects to earn between $0.10 and $0.13 per share with free cash flow in excess of $500 million.

While there is no doubt that Staples continues to face brisk headwinds, we are pleased to see the firm’s continued transformational progress.

We are most positive on its efforts to grow the profitable North America Commercial segment by focusing on mid-market customers (businesses with 10-200 employees).

While we accept that the retail business will be challenged to achieve growth anytime soon, it still generates a respectable $200 million in free cash flow each quarter making it the cash cow that can boost the firm’s investment in growth opportunities.

SPLS shares trade for less than 10 times NTM earnings expectations and offer a dividend yield of 5.5%. Our Target Price has been reduced to $11.

Already battered shares of American Eagle Outfitters (AEO) were bashed again last week after the teen apparel retailer reported fiscal Q1 2018 financial results.

While revenue of $761.8 million outpaced analyst estimates and adjusted EPS was largely in line ($0.16), the company’s disclosure of margin compression, caused by having to heavily discount after a weak start to the quarter, sent investors bolting for the exits as fiscal Q2 EPS is expected to come in well below previous projections.

While the retail environment continues to rapidly change and fashion trends are always very fickle, we continue to like that the balance sheet carries no long-term debt (though there are lease obligations) and that its investment in an online sales presence is paying off.

While Q2 guidance was certainly not as strong as we had hoped, we believe that AEO is doing the right things to drive traffic and remain popular and relevant with younger consumers. We like that the company continues to invest in Aerie, a specialty lingerie retailer and intimate store.

After the heavy whack, AEO shares trade at less than 10 times lowered forward earnings estimates and offer a 4.6% current dividend yield. Though we have trimmed our Target Price to $18, we would not hesitate to snap up AEO from the clearance pile.

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