(By Balaseshan) Brean Murray, Carret & Co. analyst Eric Beder upgraded his rating on shares of American Eagle Outfitters (NYSE:AEO) to "Buy" from "Hold" with $23 price target, ahead of the company's first quarter results.
The brokerage also increased its 2013 EPS estimate to $1.25 from $1.10 and its 2014 estimate to $1.42 from $1.29, after the company announced the closure of the money draining 77kids operation and the departure of their CFO.
Beder has been impressed with new CEO Robert Hanson's plan for the company to maximize returns; he is now impressed enough with his initial actions to aggressively raise estimates, his rating and institute a price target with implied returns of 25%.
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The analyst's new $23 price target translates to 16.2 times his 2014 EPS projection, or, adjusted for net cash per share of $3.69 at fiscal year-end 2012, 13.5 times; he believes, as an emerging turnaround play, that valuations above long term growth rates are more than justified.
To Beder, 77kids, with $40 million in revenue and a pre-tax loss of $24 million in fiscal 2012, represented everything that was wrong with prior management's almost headlong frantic dash to find some unit growth story for investors as the core business matured.
Further, the analyst believes the kid's market was highly competitive and would have been difficult to make work over the long term. As for the resignation of CFO Joan Hilson, he respects Hanson for looking for the right person to take the next step in the company's change.
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While Beder does not expect to see the chain shuttered, management has indicated that Aerie will be profitable if they eliminate about 1/3rd of the locations; he would applaud management even more for turning around a money losing 165-plus unit entity; it continues to amaze him that prior management allowed for the material growth in Aerie with limited ability for it to register solid positive returns.
The company is scheduled to release its 1Q earnings on Wednesday before the open. Beder expects guidance to remain intact beyond the positive impact of the 77kids closure; expects material inventory improvement to drive stock. If he assumes that 77kids was on track for the same pre-tax loss in fiscal 2013 as in fiscal 2012, the EPS impact would be about $0.12.
The analyst expects continued good news on inventory reductions, as 17% 1Q comp growth should have allowed for American Eagle to even more aggressively clamp down on inventory expansion to drive strong returns in the second half of 2013; he believes the company is ahead of schedule in maximizing inventory productivity.
AEO is trading up 10.43% at $20.32 on Monday.