American Eagle Is Ready to Fly

Schottenstein and his family have been involved with American Eagle since 1980, and their interests are aligned with outside stockholders. The clan owns 30 million shares worth $780 million. Given the Schottensteins' 27-year history with American Eagle and Jay's youth (just 52, as of May 1), this association is an enormous plus.

Valuation

My third step is valuation. Although the future is a question mark, we need to have a ballpark sense of what we think a business is worth because if it is too expensive, we won't make a good profit no matter how well the company does.

American Eagle's enterprise value-maintenance/enterprise free cash flow multiple is 15, for a 6.7% yield. Meanwhile, the benchmark 10-year Treasury yields 4.6%, or 210 basis points less. The stock offers a higher cash-on-cash return, plus this yield should grow over time.

If you buy the risk-free instrument and hold to maturity, your yield will remain the same. Enterprise value is market value minus cash and securities, plus interest-bearing debt and capitalized operating leases. I value American Eagle's operating leases used to finance its 900-plus stores at around $1 billion.

Maintenance enterprise free cash flow is free cash flow to the firm, minus investment in operating leases, plus growth capital spending, and the implied interest and depreciation on operating leases.

A second technique is to build a pro forma that uses various growth scenarios and also accounts for mean regression. By this method, I peg American Eagle's value at $44, and its price-intrinsic value (PIV) at an attractive 59%. The lower your PIV, the greater your margin of safety to protect against what Benjamin Graham called "miscalculation or bad luck." I assume share count grows 1% a year, which matches the last five years.

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At the time of publication, Heiserman was long American Eagle, although holdings can change at any time.

Hewitt Heiserman conceived the Earnings Power Chart and the Earnings Power Staircase. A graduate of Kenyon College with distinction in history, Heiserman is a member of the Boston Security Analyst Society and the CFA Institute. He also authored It's Earnings That Count. For additional information, please visit www.earningspower.com. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Heiserman appreciates your feedback; click here to send him an email.

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