American Eagle Gets Shot Out of the Sky

American Eagle Gets Shot Out of the Sky

The third quarter of 2013 hasn't been what anyone would call "good for retailers." Consumers are still feeling unsure about the future for a variety of reasons -- income stagnation, political gridlock, tax changes, unemployment, etc. -- leaving them less likely to buy jeans for their horrible teenage kids. While a few companies have managed to squeak by, American Eagle Outfitters isn't one of the lucky ones. The retailer's third quarter was a disaster, as evidenced by CEO Robert Hanson's recent statement that the company's financial performance was "clearly unsatisfactory."

Now that it's out there for the entire world to see, how does American Eagle stop being bad?

Third-quarter failings
On the plus side, it looks like American Eagle didn't have any locations spontaneously combust. So that's a winner. On the downside, comparable-store sales, gross margin, operating margin, and net income all fell, and some employees probably lost a few bucks on lotto tickets. Stepping back to assess the scene, it's clear that the company has fallen out of favor with its teenage core demographic.

Competitors such as The Gap managed to make small gains in the third quarter, increasing comparable-store sales slightly even in the tough environment. Gap's success came from its ability to appeal to its core demographic in a way that American Eagle failed to do. With times being so tight, every little gain makes a difference.

American Eagle looks even weaker when compared to the current hot brands. Urban Outfitters' Anthropologie brand has had excellent success all year, and in the "tough" third quarter the brand increased comparable-store sales by 13%. The whole company managed a 7% increase in comparable-store sales growth over last year, and managed to bump operating margin up at the same time.

American Eagle's plan for the future
On its earnings call, American Eagle said sales were looking better on Black Friday, but that they were also promotionally driven. Pushing margins down isn't a great plan, but it's better than nothing I suppose.

The company believes that 2014 is going to be more of the same challenge, and its plan to deal with that is threefold. First, it wants to get its clothes to market faster, so that they're relevant when they hit the shelves -- good plan. Second, it plans to move from storewide promotions to targeted promos, getting shoppers in the store without selling everything for 50% off -- good. Finally, it wants to spend less making its clothing to increase margins -- dangerous.

American Eagle simply cannot afford get a reputation for cheap merchandise. The company has said that it can drop production costs by removing "waste in [its] product that doesn't deliver intrinsic consumer value." That's a fine line to walk, and if American Eagle gets it wrong in 2014 expect things to get much worse for everyone involved.

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Fool contributor Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends Urban Outfitters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published