Despite Betting on Aerie, American Eagle’s Margins Decline on Markdowns

Besides ecommerce, retailer is contending with shifting spending habits

People walking by, in, and out of American Eagle store at a mall
American Eagle's progress hit a snag in third quarter, as gross margin took a hit from higher markdowns.
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American Eagle is betting its future on the rollout of the Aerie lifestyle brand and as a leader on inclusivity, but the retailer’s progress hit a snag in the third quarter as both gross profit and operating income fell, according to the company’s quarterly earnings report.

The retailer’s gross profit margin for the quarter ended Nov. 2 declined to 38.2% as a rate of revenue, or $407 million, from 39.8% ($399 million) for the same period in 2018, while its operating income dipped to 9.7% ($103 million) compared to 10.8% ($109 million).

CEO Jay Schottenstein said that weaker demand for some of its apparel goods led to higher markdowns, according to a statement. Such discounts, in turn, damage margins.

“Anyone can increase sales when you mark down products,” cautioned Bruce Winder, co-founder and partner of the Retail Advisors Network consultancy. He added that American Eagle, which experienced its heyday as a brand 10-to-15 years ago, is going to have difficulty selling its goods at full price.

Challenges for American Eagle include competition from a plethora of new brands online and a shift in spending by Generation Z, who already have limited budgets, toward electronics and experiences and away from apparel, Winder said.

American Eagle didn’t provide much optimism for the fourth quarter, with management expecting flat comparable sales and earnings per share of between 34 and 36 cents, versus 43 cents for the same period a year prior. And that’s excluding asset impairment and restructuring charges.

The mall-based retailer saw comparable sales at American Eagle stores increase 2%, though that was down from 5% for the same period a year prior, while Aerie’s grew 20% versus 32% last year. Comparable sales measure sales growth for stores and channels open at least one year over the comparable period in the prior year.

“They have successfully positioned Aerie as the antithesis of Victoria’s Secret, specifically with how they communicate individuality,” said David Lemley, president and head of strategy at Retail Voodoo. The chain’s message of inclusivity includes that beauty comes in all shapes and sizes, he said.

Even so, the company needs to be wary of expanding the lingerie-turned-lifestyle brand “too far, too fast,” Lemley said. “The risk a retail chain takes on when expanding rapidly is largely financial.”

Overhead and the need for same-store sales growth to keep board members and investors happy can put extra pressure on the brand to go for volume rather than margin, Lemley explained. As a result, rapid expansion threatens to produce a watered-down format that may not survive a competitive, omnichannel retail environment. “More doors of the same products that aren’t an experience isn’t a long-term solve,” he concluded.

In the latest quarter, American Eagle shelled out $58 million on capital expenditures, which included the cost of new store openings and renovations. The retailer opened six American Eagle stores during the quarter, increasing the total for that banner to 945, which includes 170 Aerie side-by-side locations. And it opened 12 standalone Aerie stores and closed one, for a total of 142 locations.

Despite the challenges, Winder said that retailers with a healthy balance sheet and a strategy that embraces new values have a shot at turning themselves around.

Concurring with Lemley, Winder said that American Eagle has had success being more inclusive with a larger range of sizes for different body types. He said the retailer, and brands like it, can build on that progressive image by being a leader in not only inclusivity, but also environmental protection, for example.

“Brands that have a cause, and don’t burn down the planet or hurt workers” have appeal to Gen Z, Winder said, though he noted that such strategies take time.

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