Chasing Value: American Eagle Will Soar Again

Before I get into the details regarding this stock I should point out that I am flying in the face of most analysts that have downgraded the stock, en masse. If that rattles your nerves, search elsewhere for stock ideas because I am a contrarian to the core. The following are some recent downgrades with links:

June 29, 2010: Brean Murray Cuts American Eagle (AEO) to Sell; Skeptical of Management.

June 28, 2010: American Eagle target lowered to $17 from $19 at RBC Capital.

June 23, 2010: American Eagle downgraded to Perform from Outperform at Oppenheimer.

There are also fans of the stock but the downgrades outweigh the upgrades. Now, back to my view.

As I mentioned the stock has a very strong balance sheet with no long term debt. That will allow the company a cushion against a double dip recession, if there is one, and the added ability to expand and eat the lunch of less prepared competitors.

I do not think AEO is going to soar immediately so you have to be patient and appreciate the higher than average yield of 3.61% to keep you comfortable while you wait. For comparison that is the same yield as Johnson and Johnson (JNJ), another company that prides itself on its financial strength. I draw this comparison also because the health care sector usually pays higher yields than the retail sector.

The PEG ratio for American Eagle is a very low 0.83, so the company is growing faster than the amount you are paying in terms of P/E. That said the P/E average combining trailing and forward looking data is around 13. The P/S, P/CF, and P/B are all much lower than the market average.

Leaving the metrics behind and looking at sales we find a very sluggish market with little sign of improvement and slow to move inventory. This is one of the major reasons that the stock has been downgraded. However, as a value investor and contrarian I have to look at all this as a buying opportunity. If one were to wait until everything was great with high visibility than the market would have bid up the stock and the opportunity would evaporate.

Perhaps there is time to wait, and the stock can stay in the doldrums for a long time. That is true, but unlike other stocks, this one has no debt with a high sustainable yield putting time on the side of AEO and its shareholders.

Update: AEO closed up, at $11.75 (+$0.14. or 1.29%) on a down day.

Sheldon Liber is the CEO of a small private investment company and the principal for design and research at an architecture and planning firm. He writes the columns Chasing Value and Serious Money. Disclosure: He own shares of AEO and JNJ.