Fall 2014 Bain & Company Project American Eagle Outfitters Analysis

 
Fall 2014 Bain & Company Project American Eagle Outfitters Analysis
Fall 2014 Bain & Company Project

American Eagle Outfitters Analysis
Fall 2014 Bain & Company Project American Eagle Outfitters Analysis
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                                                                                                   2
Fall 2014 Bain & Company Project American Eagle Outfitters Analysis
Executive Summary

                   •American Eagle Outfitters (AEO) is a casual clothing and
      Client        accessories retailer that targets 15-25 year-old consumers

    Situation      •AEO is facing declining profitability in an uncertain market

                   •What is driving AEO’s decreasing profitability?
    Questions      •What is the most effective way to increase profitability?

                   •AEO can increase revenues by entering athleisure market
 Recommendations   •It can decrease costs by moving manufacturing to Mexico

                                                                                   3
Fall 2014 Bain & Company Project American Eagle Outfitters Analysis
Declining operating margin and stock price indicate
                   poor performance
                      Operating margin has declined with a                           Stock price has declined since 2010
                             -40% CAGR since 2010

                   15%
                                                                                    25
                             11.5%              11.5%                                                      $20.55
Operating Margin

                   12%

                                                                  Stock Price ($)
                                                                                    20            $15.42
                                        8.7%                                             $14.75                     $14.69
                   9%                                                               15                                       $13.47

                   6%                                   4.2%                        10
                   3%                                                               5
                   0%                                                               0
                                 2010   2011     2012   2013

                                         Experts are       “American Eagle was once among
                                        worried about      the most sought-after apparel
                                        AEO’s recent       brands in the U.S., but it has lost
                                        performance        its essence” — Forbes

                   Source: SEC                                                                                                  4
Fall 2014 Bain & Company Project American Eagle Outfitters Analysis
Revenues have not grown quickly enough to keep up
with increasing costs

                                    Components of AEO Revenue
                      4
                                                                $3.476
                     3.5                                                         $3.306
                                              $3.120
                      3    $2.945

                     2.5
        $ Billions

                      2

                     1.5

                      1

                     0.5

                      0
                            2010              2011               2012             2013
                                    Operating Costs    Other costs   Profit

                                    Revenue =                 Operating Cost =
                                    3.9% CAGR                   6.7% CAGR

Source: SEC                                                                               5
Fall 2014 Bain & Company Project American Eagle Outfitters Analysis
The fact that AEO is positioned in the middle of the market,
despite its poor margins, suggests the market is unattractive
                                                                                           Note: GAP is significantly
                                                                                           larger because it owns
                                 20                                                        Old Navy, Banana
                                                                                           Republic, GAP, GAP Kids
                                                                                           etc.
                                 15                                                         GAP

                                 10
        Return on Sales

                                                 Abercrombie &
                                  5
                                                     Fitch

                                  0
                          -0.5         0   0.5       1       1.5   2    2.5      3   3.5   4          4.5
                                  -5       American Eagle

                                 -10

                                 -15
                                             Aeropostale

                                 -20

                                 -25
                                                         Relative Market Share

 Sources: Yahoo Finance, Company 10-Ks                                                                             6
Fall 2014 Bain & Company Project American Eagle Outfitters Analysis
Industry margins have decreased by an average of
6.7 percentage points since 2010

                                         Operating Margin by Competitor
                           21%

                           18%
        Operating Margin

                           15%

                           12%                                                           AEO
                                                                                         A&F
                           9%                                                            ARO
                                                                                         GPS
                           6%

                           3%

                           0%
                                  2010          2011        2012          2013

     Operating                   AEO          A&F       ARO        GPS           Industry
     Margin
     Percentage                  -7.3%        -4.8%     -14.7%     -.1%          -6.7%
     Point
     Change

Source: Morningstar, SEC                                                                       7
Fall 2014 Bain & Company Project American Eagle Outfitters Analysis
Revenue and cost problems each require a separate
  solution

           AEO revenue experiencing
                                        AEO margins decreasing
                  low growth
Problem

            Market experiencing low       Competitor margins
                    growth                   decreasing

               Current market is       Increase in costs is driving
                 unattractive                  this trend
Solution

                                         Identify large costs and
            Enter a new market with
                                      determine feasible actions to
                high growth rate
                                              reduce them

                                                                 8
Fall 2014 Bain & Company Project American Eagle Outfitters Analysis
Company &
 Market Analysis

 Opportunities in
Athleisure Market

Reduction in Cost
of Manufacturing

     Final
Recommendation

                   9
Fall 2014 Bain & Company Project American Eagle Outfitters Analysis
Athleisure market is the most appealing new
market for AEO to enter

                              Aligns with
                                            Barriers to   Market
                                  core                             Margins   Overall
                                              entry       Growth
                             competencies

      High-end
                                     Low       High        0.6%     3.2%
      Clothing

     Athleisure                     High       Low        16.3%    18.0%

       Outdoor                  Moderate    Moderate       2.1%    10.0%

         Fast
                                     Low    Moderate      12.0%    16.0%
       Fashion

Source: IBISWorld, Euromonitor, NASDAQ                                                 10
US athleisure market is about 10% of the US
 Sportswear market, sized at $8.17 billion

   Athleisure market is embedded in                                    Athleisure Market
     Sportswear market, which has                                          Estimate
experienced steady growth (5.6% CAGR)

                               US Sportswear Sales
                         $85                                Top-Down Approach         Bottom-Up
                                                                                       Approach
 Sales in ($) Billions

                         $80                                *Preferred method
                         $75
                         $70
                         $65
                         $60                                 $81.7 Billion US         $1.7 Billion
                               2010   2011   2012    2013   Sportswear Market     Lululemon Revenue

   Athleisure market is fragmented;                                                              The company
Lululemon is the most recognized brand                                      Athleisure         represents 20% of
                                                                         represents 10% of       the athleisure
                                                                            Sportswear              market
 •                        Lululemon
 •                        Athleta (GAP)
 •                        H&M                                            ~$8.17 Billion           ~$8.5 Billion
 •                        Foot Locker                                      Athleisure              Athleisure
                                                                            Market                  Market
 •                        Fabletics (Kate Hudson)

 Source: Euromonitor, Morningstar                                                                           11
Athleisure market is the most favorable of all
               clothing markets

                         Increasing preference for comfortable      Athleisure/Sportswear market is growing
                              clothes over regular clothes            faster than regular clothing market

                        Survey of Teenage Clothing Preferences
                       25%
Percent of Teens (%)

                       20%                                                               CAGR
                       15%                                                               (2008-13)
                       10%
                       5%                                               Regular          1.3%
                       0%                                               Apparel
                                                                        Sportswear       3.5%

                                         Athleisure      Denim

                             “The U.S. apparel industry, battered by a slowdown in mall traffic and
                             stagnant wage growth, is still seeing one category thrive: athleisure.”
                             - Bloomberg

                Source: Mintel, Euromonitor, Bloomberg                                                  12
Lululemon’s success demonstrates the athleisure
                          market’s potential

                           Lululemon is a good indicator of the overall
                           attractiveness of the athleisure market
                           because it is one of the few companies that
                           almost exclusively sells athleisure clothing

                          Lululemon has been experiencing steadily                        Athleisure clothing has lower associated
                            increasing revenue with a 44.7% CAGR                             COGS as a percentage of revenue

                          1600                                                            70%
Revenue ($) in Millions

                                                                                          60%
                          1200
                                                                                          50%
                                                                           % of Revenue
                                                                                          40%                                Lululemon
                           800                                                                                                 COGS
                                                                                          30%                                AEO COGS

                           400                                                            20%

                                                                                          10%
                             0                                                            0%
                                      2010           2011    2012   2013                        2010   2011   2012   2013

                          Source: Euromonitor, Morningstar                                                                       13
Barriers to entry include customer loyalty and
advertisement spending, but can be overcome

   Customer
                                                       Advertising
    Loyalty                                                          Barrier:
                        Barrier:
                                                                     AEO currently unknown
                        Large players’ high
                                                                     in the athleisure market
                        quality and variety of
                                                                     and requires large
                        products (i.e.
                                                                     marketing expenses to
                        Lululemon)
                                                                     gain recognition

                        Response Strategy:                           Response Strategy:
                        Attract consumers by                         AEO can afford to incur
                        offering a lower price                       higher advertisement
                        point                                        expenses because it will
                        - “48% of Lululemon’s                        not have to invest in
                        customers “extremely likely”                 additional capital
                        to switch to cheaper
                        products”                                    expenses

Source: Surverymonkey                                                                      14
Organic production strategy would be the best way
for AEO to enter the market

                   M&A                                 Joint Venture          Organic Production

 • Pros                                            • Pros                   • Pros
   • Strong market                                   • Sharing risk           • High product
     impact                                          • Medium design            design flexibility
   • Faster growth                                     flexibility            • Control over costs
   • Lower barriers to                               • Lower barriers to        and revenue
     entry                                             entry                  • Lowest costs by
 • Cons                                            • Cons                       using existing
   • Very expensive                                  • Medium costs             facilities and
                                                                                outsourcing
   • Highest risk                                      • R&D costs
                                                                                contracts
     • Integration Issues                            • Medium product
                                                                              • Least risk if failure
     • Financial fallout                               design flexibility
                                                                            • Cons
   • Low product                                     • Integration issues
                                                                              • R&D costs
     design flexibility                              • Not long term
                                                       solution               • Average barriers to
                                                                                entry
                                                       • 80% of ventures
                                                         end in a sale

Source: VR Business Sales Edmonton, Deal Capital                                                   15
AEO’s athleisure prices will be above H&M’s and
 below Athleta’s and Lululemon’s

                   Yoga Pants                                Fitness Shorts

                            AEO: $65 Lululemon: $81             AEO: $35 Lululemon: $51

H&M: $25                       Athleta: $69       H&M: $15           Athleta: $39

               Fitness T-Shirt                           Hoodie/Sweatshirt

                            AEO: $45 Lululemon: $52      AEO: $65         Lululemon: $112

H&M: $24                       Athleta: $49       H&M: $40          Athleta: $94

 Source: Company websites                                                           16
If AEO captures 3% of growing US athleisure market,
                           it will increase revenue by $423 million by 2018

                                  Sportswear and Athleisure Markets                                                                     AEO’s Athleisure Market Revenue
                                              Forecast                                                                                              Forecast
                    100
                                                                                                94                                           US Sportswear Sales
Revenue in ($) Billions

                                                                                                            Revenue from Athleisure
                          80                                            90           92
                                                 87
                                                                                                                                      500

                                                                                                                Sales ($Millions)
                          60          69
                                                                                                                                      400
                          40                                                                                                          300
                          20                                                12       13                                               200
                                        8        10                                             14
                           0                                                                                                          100
                                   2014      2015       2016                      2017       2018                                       0
                                       US Sportswear Sales                       Athleisure Market                                           2014   2015      2016   2017         2018
                               Assumption: Athleisure’s share of Sportswear                                            Assumption: AEO will capture 3% of the
                               market will grow from 10% to 15% in 2018                                                athleisure market by 2018

                                                                                                           AEO Market Share by 2018
                                                                                                     2%                                     3%             5%           10%
                                Sensitivity
                                                      Athleisure share of
                                                      Sportswear Market

                                Analysis for                                      10%                188                                    282            470              940

                                 athleisure                                       15%                282                                    423            705          1410
                                market and
                                AEO shares                                        20%                376                                    564            940          1880

                                                                                  25%                470                                    705            1175         2350

                           Source: Euromonitor                                                                                                                                     17
Company &
 Market Analysis

 Opportunities in
Athleisure Market

Reduction in Cost
of Manufacturing

     Final
Recommendation

                   18
COGS are driving increased costs; manufacturing, labor, and
                 logistics are addressable components of COGS

                       Operating costs are increasing; COGS are a                                     COGS are increasing at a higher
                           significant portion of these costs                                           rate than operating costs
                 3.5

                  3                                                                                           CAGR of
                                                                                                                             CAGR of
                                                                                                             operating
                                                                                                                              COGS
                 2.5                                                                                           costs
                  2
$ Billions

                                                                                            Other

                 1.5                                                                        SG&A

                                                                                                             6.7%            7.5%
                                                                                            COGS
                  1

                 0.5

                  0
                               2010   2011                     2012              2013

             Components of                                 Raw Materials costs have                     1.    With raw materials costs
                COGS                                             decreased                                    declining, we do not need to
                                                      2                                                       address this component

             •    Raw Materials                      1.5
                                      Price ($ per

                                                                                                        2.    Data is not available to address
             •    Manufacturing
                                        pound)

                                                      1                                   Cotton              merchandising costs
             •    Labor
                                                                                          Polyester
             •    Logistics                          0.5                                                      This leaves manufacturing,
             •    Merchandising                                                                               labor, and logistics as the costs
                                                      0
                                                            2010   2011   2012     2013
                                                                                                              that we want to reduce

                 Source: SEC                                                                                                              19
China/North Asia accounts for most of AEO’s
                  production; costs in this region are higher than and
                  rising relative to other countries
                        Majority of AEO’s production is done in                                   There are countries that are cheaper than
                                 China and North Asia                                                     China to manufacture in
                                             22                                                                          100
                                 58                            Americas

                                                                                           Cost of Manufacturing
                                                                                                                   100         97   96
                                                                                                                    95                   91   91
                                                               China & North Asia                                   90                             87

                                                                                                   Index
                                                                                                                    85                                  83
                                                               Europe, Middle
                        59                                                                                          80
                                                               East, & Africa
                                                                                                                    75
                                                               South Asia
                                                     185
                             5
                                                               Southeast Asia
                              Number of factories

                    China’s Yuan has appreciated relative to                                                             Inflation pressures in China
                    the U.S Dollar; the Peso has depreciated
                                                                                                       Within 5 years, wages are expected to be 25%
                        16                                                                             higher in China than in Mexico
Currency Value Per US

                        14
                        12
                                                                                                       China’s unit cost has grown over 60% since 2007
                        10                                                                             due to Yuan appreciation
       Dollar

                         8                                                  Yuan
                         6                                                  Mexican Peso
                                                                                                       Energy costs have risen and continue to do so
                         4                                                                             due to China’s industrialization and increased
                         2                                                                             consumption by its people
                         0
                             2005     2007    2009    2011   2013
                  Source: AEO, Economist, IBC, BetterWorld                                                                                               20
Mexico is a more appealing location to
 manufacture than China

These other companies have moved most                             China                      Mexico
of their manufacturing to Mexico                         Cost of Manufacturing       Cost of Manufacturing
                                                         index is 96 (U.S is 100)    index is 91 and shrinking
                                                                                     relative to China

                                                         Current natural gas         Natural gas is tied to the
                                                         prices are 64% higher       U.S’s natural gas
                                                         than Mexico’s prices        resources, resulting in
                                                                                     lower prices

                                                         Long transportation         Connected to U.S via
                                                         routes to transport goods   land, making goods
                                                         to the U.S, which also      transportation easier and
                                                         makes quality control       faster, and makes quality
                                                         more difficult              control easier

                                                         Currently have export       Tariff free imports to the
                                                         tariffs are 15.9%           U.S under NAFTO
Trends in Percentage of United States Imports
U.S.Stats  about    imports U.S. imports from China      In recent events,           Some concerns over
     imports  from Mexico
                                                         intellectual property       security that are solved
have steadily increased to  have remained stagnant at    rights have been            by using guards at
14.4% of all U.S. imports   19% for the past 3 years     compromised by police       manufacturing hubs
over the past decade                                     forces and hackers

 Source: Census Bureau, IBC, USAToday, Economist, WSJ,                                                     21
AEO can best launch Mexican manufacturing
operations by following a five step process
                               Choose production facilities to terminate operations within China
           1                   based on expiration date of contract, consistency and quality of
                               work, social responsibility history and costs of manufacturing and
                               logistics

                               Initiate new sourcing relationships in Mexico, starting with Mexico
           2                   City where AEO currently owns 5,800 sq ft of office space, 2 major
                               flag ship stores, and maintains a highly competent management team

                               Encourage other clothing retailers in different markets to partner
           3                   with AEO in these sourcing relationships to reduce costs and share
                               best practices

                               Once locations to close and open have been selected, move
           4                   production centers at staggered intervals, preferably at periods of
                               low location usage

                               Analyze the impact of moving production and continue to move
           5                   production until the mix of factory locations is optimized

Source: http://www.ae.com/Images/corpResp/AEBetterWorldNew.pdf                                       22
Considerations must be made in order to reduce risk,
 but overall this is a low-risk solution

                                                            Production can
Certain factors must                                        easily be moved
                                                           back to China due
  be considered in                                         to AEO’s sourcing
 order to mitigate                                               model

        risks

  Gang-related violence in
                                              Production can be
          Mexico
                                              moved one factory                   Low
                                              at a time, allowing
                                                   for AEO to
                                                                                proposed
                               However,        constantly assess                   risk
     Mexican sourcing                             the impact
  companies may not have
                               overall this
     the expertise to          is a very
 manufacture AEO products
                               low-risk
                               solution
     Mexico can possibly
 become more expensive to                                  AEO does not own
  produce in, though this is                               factories to begin
                                                                  with
       highly unlikely

                                                                                      23
AEO can reduce COGS up to 2.4% by shifting
  production to Mexico
                 Calculation process                                                     Savings based on two scenarios

                                                                                    Move 50% of Chinese and North Asian Factories to
          COGS                                                                                          Mexico
                                                                                  Year           Manufacturing &             Percentage of COGS
                                     60% of COGS are from                                       Labor Savings ($M)                 Savings
                                     manufacturing and labor*
                                                                                  2014                  16.5                         0.7%
 Manufacturing &                                                                  2015                  21.5                         0.9%
   Labor Costs                                                                    2016                  26.9                         1.1%
                                     56% of goods made in                         2017                  32.8                         1.3%
                                     China/North Asia
                                                                                  2018                  39.0                         1.6%
China Manufacturing
   & Labor Costs                     Manufacturing Cost in Mexico
                                     is 95.8% of that of                            Move 75% of Chinese and North Asian Factories to
                                     China/North Asia (and will                                         Mexico
                                     decrease to 91.8% by 2018*),                 Year           Manufacturing &             Percentage of COGS
                                     then multiply by percentage                                Labor Savings ($M)                 Savings
Mexico-China Mix                     of factories to be moved
Mfg. & Labor Costs                                                                2014                  24.7                         1.0%
                                                                                  2015                  32.2                         1.3%
                                     Savings = China/North Asia
                                     Costs − Mexico Costs                         2016                  40.4                         1.6%
                                                                                  2017                  49.1                         2.0%
 Manufacturing &
  Labor Savings                                                                   2018                  58.5                         2.4%
                                     *Assumption

  Source: http://www.fcbco.com/articles-and-whitepapers/articles/bid/129456/Controlling -and-Reducing-Your-Fulfillment-Costs, CBIC                24
AEO can also save money on shipping, with total
 combined savings reaching up to 4.5% of COGS
                Calculation process                                                      Savings based on two scenarios

                                                                               Move 50% of Chinese and North Asian Factories to Mexico
        COGS
                                                                              Year           Shipping            Total Savings      Total Percent of
                              8% of COGS are from                                          Savings ($M)              ($M)            COGS Savings
                              shipping*                                       2014              33.4                  49.9               2.8%
                                                                              2015              36.1                  57.6               3.0%
     Shipping                                                                 2016              39.0                  65.9               3.2%
                                                                              2017              42.2                   75                3.4%
                              56% of goods shipped from
                              China/North Asia                                2018              45.6                  84.6               3.7%

China/North Asia
 Shipping Costs               Shipping cost in Mexico is                       Move 75% of Chinese and North Asian Factories to Mexico
                              37% of shipping cost in
                              China/North Asia, then                          Year           Shipping            Total Savings      Total Percent of
                              multiply by percentage of                                    Savings ($M)              ($M)            COGS Savings
Mexico-China Mix              factories to be moved
                                                                              2014              50.1                  74.8               3.1%
 Shipping Costs
                                                                              2015              54.2                  86.4               3.4%
                              Savings = China/North Asia
                              Shipping Costs − Mexico                         2016              58.6                   99                3.8%
                              Shipping Costs                                  2017              63.3                  112.4              4.1%

Shipping Savings                                                              2018              68.4                  126.9              4.5%

                               *Assumption

 Source: http://www.fcbco.com/articles-and-whitepapers/articles/bid/129456/Controlling -and-Reducing-Your-Fulfillment-Costs, CBIC               25
Moving 75% of factories to Mexico will increase
projected operating margins by 3%, but margins will
continue to decline
                                                 AEO Operating Margin
                        14%

                        12%
     Operating Margin

                        10%

                        8%

                        6%

                        4%

                        2%

                        0%
                                2010   2011     2012     2013     2014     2015    2016      2017     2018

                              Known    Projection if cost solution implemented    Projection if no change

                               Reducing costs alone is not enough. Revenues must also be
                                   increased in order to stabilize operating margin.

Source: SEC                                                                                                  26
Company &
 Market Analysis

 Opportunities in
Athleisure Market

Reduction in Cost
of Manufacturing

     Final
Recommendation

                   27
Entering the athleisure market and implementing the
cost savings strategy will cause operating margin to
stabilize at 6.5%

                                                  AEO Operating Margin
                      14%

                      12%                                                                                 Margin
                                                                                                          stable at
                      10%                                                                                 6.5%
   Operating Margin

                      8%

                      6%

                      4%

                      2%

                      0%
                             2010     2011     2012      2013     2014       2015      2016        2017   2018

                       Known                                             Projection if no change

                       Projection if both solutions implemented          Projection if cost solution implemented

Source: SEC                                                                                                        28
Questions?

             Thank you for your time!

                                        29
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