American Eagle: Debt Landing
After the market closed today, American Eagle Outfitters ($AEO) reported their first quarter results. The stock went up 15% in the after hours, and I tweeted this:
Then, well, I decided to fact-check myself. American Eagle’s management and shareholders love to talk about their balance sheet having no debt, leading to financial flexibility. Unfortunately, AEO’s finances are not as flexible as I previously thought.
I’ll elaborate in a minute, but I also wanted to point out another tweet I made last Tuesday regarding $AEO and L Brands ($LB):
While I still think a combination of Victoria’s Secret and Aerie would be an extremely dominant force in women’s underwear, I’m not so sure a company with nearly $9B in total liabilities and under $3B in cash wants to take a bet on AEO. Not only does the male apparel side diverge from their core strategy, but I believe AEO will soon be taking on debt for the first time. Maybe a company like Amazon ($AMZN) or Target ($TGT) would be willing to snatch them up for their budding fashion dreams instead.
Back to the meat of the story: American Eagle’s finances are nowhere near as clean as I remembered. Unfortunately, I believe AEO is making a major mistake many other companies are making. AEO’s management has instated a buyback program that is eating their cash pile alive while leaving their liabilities growing. Take a look at some stats from their 10-K:
AEO’s net revenue and net income over the past five years haven’t been consistent at all. This next fiscal year will determine if their “2016 year” was just another peak in their cycle. I believe these two statistics are the reason the stock has traded in a range for years. However, I have always believed that this was a “turnaround” company working fast to defend against other retailers and Amazon. I was under the impression that AEO was closing a ton of stores and making leaps and bounds in their online efforts. Since 2013, AEO’s capex have declined by nearly half, and their total stores at year-end has actually been in decline since 2014. Their total selling square feet, however, fluctuates with an uptrend over the past five years but a flattening over the last three. Though their number of employees has been declining since 2014, hinting at a strong online presence and store closures, we see that these lower employment levels have been reached in the past as well. When I look at this data, it makes me question my thesis of AEO switching to a primarily online model, but maybe the switch is really just starting in the past three years. If you’ve ever used their mobile app or website, you would see that they are actually one of the best in the game of implementing technology into their strategy. Their return policy is also top-notch, encouraging customers to shop online. By the way, their C-suite is getting pretty old.
One account on their balance sheet is extremely consistent in its decline, Total cash and short-term investments/Cash and cash equivalents — end of period:
And there it is. Now we can see just why their cash balance has declined significantly. Even after cutting capex in half and reducing headcount, AEO has taken their cash balance to extremely low levels in favor of massive share repurchases. As I wrote about just recently, it is often a mistake to repurchase your company’s own stock. If I was a shareholder, I would much prefer a small boost in the dividend. If I was accepting of a stock trading in the same range for years on end (which I’m not), I’d at least want to compound faster.
At this point, I’ve seen just about enough of this buyback crap to know exactly what’s about to happen. AEO will most likely take on “x” amount of debt to buy back their stock, and eventually look for a seller when they’re tired of making no impact on the stock price over time. That’s just how it works nowadays, right? It doesn’t seem to me like they notice this incredible decline in their cash balance as their expenses go down.
To the “no debt!” people, I’ve got another table for you:
They ignored these liabilities, no matter if they’re considered traditional “debt” or not. They do consist primarily of accounts payable, and liabilities are liabilities. Maybe AEO’s management will pause their buyback program and take some time to pay off these liabilities, but I doubt it. If management said that they will pause their repurchase program or will stop when debt needs to be raised, I am calling their bluff right now.
After all, we are in the “Buyback Era”.