Buy Report

Luke Parkhurst Andrew Swanson Matt Unger

American Eagle Outfitters Inc. (NYSE: AEO) General Stock Info Recent Price: $16.75 P/E (ttm): 9.27 Beta: 1.28 52 Week High: $31.23 (April 07) 52 Week Low: $16.00 (April08) Shares Out.: 204.9 million Shares Short: 9.78 million Market Cap.: 3.33 billion Enterprise value: 2.71 billion

Company Profile1
American Eagle Outfitters, Inc. is a retailer that markets and sells its own brand of laidback, current clothing targeting 15 to 25 year-olds, providing high-quality merchandise at affordable prices. The original collection includes standards like jeans and graphic t-shirts as well as essentials like accessories, outerwear, footwear, basics and swimwear. The American Eagle brand also includes Aerie brands, MARTIN + OSA brands, and 77Kids by American Eagle. As of February 2nd, 2008, the company operated 929 stores in the United States and Canada, 39 Aerie stand-alone stores and 19 MARTIN + OSA stores. American Eagle also operates ae.com, which ships to more than 40 countries around the world.

Recommendation: Buy 3,500 Shares Bull Summary - Undervalued on a multiple and cash flow basis - Worst case scenario already priced in the stock - Should outperform more expensive peers in a consumer slowdown - High potential for growth with aerie brand, yet we remain conservative on our estimation of the brands performance -Outstanding target market brand recognition - Trading at 52-week low General Company Info Sector: Consumer Discretionary Industry: Apparel Stores Headquarters: Pittsburg, PA Index Memberships: S&P 400 Mid Caps, S&P 1500 Super Comp Established: 1977

American Eagle Outfitters, Inc. 10-K Report

Company Profile2
American Eagle Outfitters, Inc. is a retailer that markets and sells its own brand of laidback, current clothing targeting 15 to 25 year-olds, providing high-quality merchandise at affordable prices. The original collection includes standards like jeans and graphic t-shirts as well as essentials like accessories, outerwear, footwear, basics and swimwear. The American Eagle brand also includes Aerie brands, MARTIN + OSA brands, and 77Kids by American Eagle. As of February 2nd, 2008, the company operated 929 stores in the United States and Canada, 39 Aerie stand-alone stores and 19 MARTIN + OSA stores. American Eagle also operates ae.com, which ships to more than 40 countries around the world.

Segments3
Aerie Brand During Fiscal 2006, American Eagle launched its new intimates brand, aerie by American Eagle (aerie). The aerie collection is available in aerie stores, predominantly all American Eagle stores and at aerie.com. The collection includes bras, undies, camis, hoodies, robes, boxers, sweats, leggings, fitness apparel and personal care for the AE girl. Designed to be sweetly sexy, comfortable and cozy, the aerie brand offers AE customers a new way to express their personal style everyday, from the dorm room to the coffee shop to the classroom. MARTIN + OSA Brands The company also introduced MARTIN + OSA during Fiscal 2006, a concept targeting 28 to 40 year-old men and women, which offers refined casual clothing and accessories, designed to be valuable, irresistible, inspiring, authentic and adventurous. MARTIN + OSA is sold exclusively at their respective stores and at martinandosa.com. 77Kids In January 2008, the company announced plans to launch a new childrens apparel brand. 77Kids by American Eagle (77Kids) will offer on-trend, high-quality clothing and accessories for kids age two to 10. The brand will debut worldwide online at 77Kids.com during Fiscal 2008, with stores in the U.S. expected during 2010.

R evenue B reakdown by S m eg entation (Units Millions : ) 2000 1500 1000 5 00 0 2005 200 6 2007 20 08 Wom en'sApparel Men'sApparel F ootwear

2 3

American Eagle Outfitters, Inc. 10-K Report American Eagle Outfitters, Inc. 10-K Report

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Company History4
1977: American Eagle Outfitters (AE) is launched as segment of Silvermans Menswear, Inc. 1980: Company struggles financially throughout the 80s, changes company focus. 1992: The Company focuses on private-label merchandise. 1994: American Eagle Outfitters goes public, listed on the NASDAQ stock exchange (AEO). 1998: Abercrombie and Fitch sues AEO for copying concept; case dismissed 3 times in 4 years. 2005: Company expands to all 50 states 2006: AEO launches MARTIN + OSA (28 to 40 year-old target) and Aerie by American Eagle (female-focused brand).

Recent News5
April 10th, 2008: AEO cut Q1 earnings forecast to 18 to 20 cents a share, down from its previous expectation of 25 to 28 cents a share. The cut was in response to the companys decline in same store sales for the month of March. April 3rd, 2008: AEO launches MARTIN + OSA website to enhance the online shopping experience of the companys 28 to 40 year-old brand. March 7th, 2008: American Eagle Outfitters Inc approved a dividend of $0.10 per share. January 9th, 2008: American Eagle Outfitters, Inc. Lowers Q4 2007 EPS Guidance October 10th, 2007: American Eagle Outfitters, Inc. Lowers Q3 2007 EPS Guidance

Management6
Jay L. Schottenstein Chairman of the Board Mr. Schottenstein has served as Chairman of the American Eagle Outfitters and its predecessors since March 1992. He served the Company as Chief Executive Officer from March 1992 until December 2002 and prior to that time, he served as a Vice President and Director of the Companys predecessors since 1980. He has also served as an officer and director of various other corporations owned or controlled by members of his family since 1976. James V. ODonnell Chief Executive Officer, Director Mr. ODonnell has been with AEO since 1999 (CEO since 2002). Prior to coming to AEO he was the COO of The GAP, as well as working with various technology retailing companies. He has been successful in implementing his IT knowledge to enhance the efficiency of AEO. Susan McGalla President, Chief Merchandising Officer Ms. McGalla has served as President and Chief Merchandising Officer of American Eagle Outfitters, Inc. since March 2007. She has been with the company and held various merchandising positions since 1994. Joan Hilson Chief Financial Officer, Executive Vice President Ms. Hilson has served as Executive Vice President, Chief Financial Officer, AE Brand, and Principal Financial Officer of American Eagle Outfitters, Inc since April 2006. Prior thereto, Ms. Hilson served the Company as Senior Vice President, Finance since September 2005. Prior to joining the Company, Ms. Hilson held various positions at the Victorias Secret Stores division of Limited Brands, Inc., including Executive Vice President and Chief Financial Officer

4 5

American Eagle Outfitters, Inc. Investor Relations website Yahoo! Finance 6 http://stocks.us.reuters.com/stocks/officersDirectors.asp?symbol=AEO

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Competitors7
Abercrombie & Fitch Co. (NYSE: ANF) Abercrombie & Fitch Co. operates as a specialty retailer of casual apparel for men, women, and kids. Its stores offer casual sportswear apparel, including knit and woven shirts, graphic t-shirts, fleece, jeans and woven pants, shorts, sweaters, and outerwear, as well as personal care products and accessories under Abercrombie & Fitch, abercrombie, Hollister, and RUEHL brands. As of February 2, 2008, it operated 1,035 stores in the United States, Canada, and the United Kingdom. Abercrombie & Fitch Co. also sells its products through Web-based stores, as well as through a catalogue. The Gap Inc. (NYSE: GPS) The Gap, Inc., through its subsidiaries, operates as a specialty retailing company. It operates retail and online stores that sell casual apparel, accessories, and personal care products for men, women, and children under the Gap, Old Navy, Banana Republic, and Piperlime names. The company's products include wardrobe basics, such as denim, khakis, and T-shirts; women's underwear, sleepwear, loungewear, and yoga gear; fashion apparel; shoes and accessories; maternity apparel; and personal care products. As of February 2, 2008, it operated 3,167 store locations in the United States, Canada, the United Kingdom, France, Ireland, and Japan. J. Crew Group, Inc. (NYSE: JCG) J. Crew Group, Inc. operates as a multi-channel specialty retailer of women's, men's, and children's apparel and accessories in the United States. Its retail products include wedding and special occasion attire, weekend clothes, swimwear, loungewear, outerwear, shoes, bags, belts, hair accessories, and jewelry. The company also sells its products through catalogs and Internet. As of February 2, 2008, it operated 199 retail stores and 61 factory stores in 40 states and the District of Columbia.

Ownership8

We feel the 22% decrease in ownership in the last 12 months was in response to the weakening macro-economy and fear of recession. In general, the consumer discretionary sector and retailing industry tends to underperform the market in times of economic slowdown.
7 8

Yahoo! Finance Fidelity.com

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SWOT Analysis9,10,11
Strengths AEO designs their own lines and works with third party manufacturers abroad to get their final products to inventory. To date, management has been successful with predicting trends and offering a compelling product which consumers are willing to buy. The companys excellent brand recognition provides a slight moat to the firms revenues. It was ranked 2nd in terms of brand recognition in a recent teen research survey from kids aged 12-19. AEOs management team has numerous years experience both with the company and the retailing industry. The CEO, James ODonnell, has exposure to the IT industry and been successful implementing various systems which have improved the efficiency of the company. They have improved inventory mix and are in the process of testing new sales tools in some stores to enhance the shopping experience and drive more sales. AEO has over $600M in cash and cash equivalents with $0 in debt, which is ample to help support their new concepts like Martin + OSA and Aerie as they are in start-up stages. These have potential to be future cash cows over the next ten years as they begin to mature. The company is working to improve turnovers and current operations through the use of capex, which is funded purely through revenues and equity, thus leaving the company free of debt at a turbulent time in the economy. Weakness The companys core brand is becoming saturated in the US and Canada, which is only represented by the online presence today. The new brand concepts could prove to be a distraction to its core brand in the short-term if these projects are not resourced appropriately. The company is not considered best in breed in a sense of quality, as many consumers believe the company to be a tier below its main competitors like Abercrombie & Fitch and JCrew. There has been some concern that MARTIN + OSA are dragging the profitability of AEO, but management reaffirmed their commitment to the new brand this week. Opportunities The MARTIN + OSA brand also presents an opportunity because there is a possibility of a sale of the brand. The fact that AEO has limited international exposure allows for expansion into many markets in which they have not yet entered. It appears as though AEO is currently looking for a partner that may have local experience in Europe. A more recent brand launch, 77Kids, possesses a large possible to gain market share in a new age bracket for the company. This new concept will be launched online during late 2008 and opening stores as soon as 2009. The company has several initiatives to improve its operating margins, such as limiting promotional activities, implementing a price-optimization system, and fine-tuning its supply chain. The Aerie brand targets the core 15 to 25 year old market, but adds additional variety (intimate apparel) that will draw more customers and may increase the average ticket sales
9

http://seekingalpha.com/article/71655-american-eagle-ready-to-fly-high American Eagle Outfitters 10-K Report 11 Teenresearch.com

10

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driving up same store sales. In addition to these three new concepts that could easily turn into $1billion brands, each are beginning to look at additional international expansion. Threats The fashion industry is constantly changing, which leads to the potential for change without AEO following. An example of this is the decline in personal spending on apparel since the 1980s. Young adults will continue to spend more on gadgets like mobile phones and digital music players. Poor inventory planning could lead to larger than expected write downs, thus drastically reducing margins and adding the potential risk of diluting equity through the offering of more shares. Low barriers into the clothing retail market leads to increased competition which could offer cooler brands and/or better pricing, thus reducing AEOs profit share. Lastly, we are experiencing a slowing economy. Last time that happened, AEO saw sales slow, thus margins declined which is the current situation for the industry.

Economic Outlook for Consumer Discretionary 2008

Consumer Discretionary was the second worst performing sector of the S&P 500, beating only the meltdown by the Financials. Consumer Discretionary took the brunt of the slow-down in the U.S. economy during the later part of 2007. Since this slow-down is expected to continue for at least the first half of 2008, these companies will most likely continue to encounter difficult times, especially as unemployment rises. Consumers are also controlling their spending due the problems in the credit markets and the negative wealth effect from declining home prices. Politics will have an impact on some parts of this sector as well as the economy. For example, the economic stimulus package the federal government is planning is supposed to help stimulate the economy through a $146 to $157 billion bill that would give tax credits and rebates to 117 million people. This money from the stimulus package is expected to add 0.2% to the GDP in the quarter it is distributed. Although the jump in GDP may increase sales in the short-run, this sector is likely to continue to under perform the S&P 500 until investors believe the U.S. economy is at, or near a bottom. The important indicators to watch will be consumer sentiment and the unemployment rate.

Analyst Recommendations
We are tempted by AEOs valuation and strong cash position; however, 1) continued weakness across womens categories, 2) a lack of product newness, 3) 1H margin pressure from a denim reassortment, and 4) the absence of a significant catalyst will likely pressure the shares in the near term. -Morgan Stanley Equity Analyst Michelle Clark, Position: Hold (Target Price: $18) AEO is clearly not immune to the soft retail environment. However, with 1) very low valuation, 2) very strong balance sheet and 3) strong teen brand positioning, we continue to believe in this story. We believe the core brand is structurally in great shape and do not think this is a broken story. Also, while mgmt remains committed to the struggling MARTIN + OSA concept, we think the potential closure of this business (maybe as soon as this summer) provides some implied support to the stock. -Bear Stearns Equity Analyst Randal Konik, Position: Buy (Target Price: $27) We believe AEO's first half will be tough due to a soft women's business, especially in bottoms. The company plans to clear through inventories to be totally forward facing for new denim trends by back-to-school '08. We're encouraged by conservative inventory planning but remain cautious ahead of several quarters of low top-line visibility and meaningful margin erosion. -Lehman Brothers Equity Analyst Jeff Black, Position: Hold (Target Price: $20) Based on weaker than expected March comps, we are reducing our 1Q08E from $0.26 to $0.18. Longer-term, we believe the company has good growth prospects from aerie, though the rapid pace of store expansion in 2008 may prove difficult. In addition, given challenges in the overall business

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and macroeconomic environment, MARTIN & OSA seems to be an unnecessary distraction. -Credit Suisse Equity Analyst Paul LeJuez, Position: Hold (Target Price: $17)

FINANCIAL STRENGTH
A e ic nE g O t te s m r a a le u fit r
AE O Quick R atio C urre R nt atio L D bt to E T e quity Inte st C e e(T M) re ov rag T 1.95 2.71 Indus try 0.96 2.08 0.39 2.65

v C m e it r s o p t io s
AN F 1.36 2.10 G PS 1.03 1.68 0.01 0.04 JC G 0.90 1.71 0.89 9.84 1.10 1.83 0.89 9.84

Pe r Av e g.

The company is in great financial health, with no long-term debt and over three dollars a share in cash. Essentially, American Eagle has been able to generate enough cash internally to fund its expansion plans. Although this shows that they are not utilizing all of their potential leverage during recessionary periods, during our current slowdown, zero or minimal debt is an extremely good situation to be in. Financial Strength Rating: Very Good

ASSET MANAGEMENT ANALYSIS

Am erica E g vsC petitiors n a le om
AEO Total Asset Turnover (ttm) Receivables Turnover (ttm ) Inventory Turnover (ttm) Days Sales in Inventory (ttm) 1.59 105.42 5.93 64.06 Industry 1.95 47.28 4.67 Peer Avg. 2.08 111.21 4.59 77.60 ANF 1.56 77.28 2.79 98.18 5.98 57.08 GPS 1.92 JCG 2.77 145.13 4.99 77.55

Am erica E g H n a le istorica T l rends

AEO 2007 Total Asset Turnover Receivables Turnover Inventory Turnover Days Sales in Inventory 1.59 105.42 5.93 64.06 AEO 2006 1.56 101.26 6.13 66.18 AEO 2005 1.58 83.56 6.53 61.82 AEO 2004 1.66 74.41 6.89 62.05

American Eagle has been trying to improve its efficiency, especially in its merchandise transportation system. For example, in order to cut cost and grow at the same time, American Eagle during Fiscal 2007 entered into a lease of a 294,000 square foot building to house a Canadian distribution center which they plan to place into service in May 2008. This will be used to reduce cost northern division. American Eagle has also been focusing on the allocation of merchandise among stores varying based on a number of factors, such as geographic location, customer demographics and store size. Also, during Fiscal 2007, American Eagle completed the first phase of expansion at our Ottawa, Kansas distribution center. The expansion of the distribution center enabled AEO to bring the fulfillment services for AEO Direct in house. Previously, AEO Direct utilized a third party vendor for its fulfillment services. The second phase of the expansion will be completed in Fiscal 2008

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and is designed to enhance AEO operating efficiency. Additionally, the expansion is central to plans for supporting future growth, especially in areas such as AEO Direct, aerie, MARTIN + OSA and 77kids. Everything in this analysis looks relatively average except Receivables Turnover. By maintaining Accounts Receivable, firms are indirectly extending interest-free loans to their clients. A high ratio implies that a company either operates on a cash basis or that its extension of credit and collection of accounts receivable is efficient. Assuming that much of their sales are on credit, Receivables Turnover ratio does not look very good and seems to be getting worse, but they still outperform peers. Asset Management: Average

PROFITABILITY ANALYSIS
A erican Eagle vs Com m petitiors
AEO Gross Margin (ttm) Operating Margin (ttm) Net Profit Margin (ttm) 46.58% 19.60% 13.09% Industry 37.66% 9.94% 6.35% Peer Avg. 48.11% 13.86% 8.49% ANF 66.97% 19.75% 12.69% GPS 35.11% 8.92% 5.50% J CG 42.26% 12.92% 7.27%

A e ic nE g H to ic l T e d m r a a le is r a r n s
AE 2007 O G ross Marg in Ope ratingMarg in Profit Marg in 46.58% 19.60% 13.09% AE 2006 O 47.97% 21.00% 13.86% AE 2005 O 46.42% 19.75% 12.67% AE 2004 O 46.66% 19.28% 11.34%

American Eagle has reduced markdown selling and leveraged fixed cost like occupancy and payroll over higher sales. Although Gross Margin and Profit Margin have not increased much, they still outperform the industry and Peer average. Operating income as a percent to net sales was 19.6% for Fiscal 2007 compared to 21.0% for Fiscal 2006. The decrease was driven by a decline in gross profit and increased depreciation and amortization expense. This was partially offset by an improvement in selling, general and administrative expenses as a percent to net sales. Overall it is evident margins remain considerably impressive relative to the industry and American Eagles direct peers. Profitability Rating: Very Good

MANAGEMENT EFFECTIVENESS ANALYSIS

A eric nE g v C p m a a le s om etitiors
AE O R (TTM) OA R (TTM) OE R (TT OI M) 20.80% 29.01% 26.61% Industry 11.81% 25.76% 16.68% Peer Avg. 16.83% 60.95% 24.01% ANF 19.76% 31.47% 25.29% GPS 10.58% 18.35% 14.85% JC G 20.15% 133.03% 31.90%

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Am erica E g H n a le istoric l T a rends

AEO 2007 ROA (TTM) ROE (TTM) ROI (TTM) 20.80% 29.01% 29.01% AEO 2006 21.61% 30.11% 30.11% AEO 2005 20.05% 27.76% 27.76% AEO 2004 18.87% 26.65% 26.65%

American Eagles returns are very solid and show strong management effectiveness. Return on Equity is about average excluding the extremely high Return on Equity JCrew has. Overall, average in this industry is still very good being that the industry has such high returns. Even though returns are lower than 06, this is mainly due to the decline in margins as a result of a slowdown in the economy. Management Effectiveness: Average

GROWTH ANALYSIS
Am erica E g vsCom n a le petitiors
AEO Sales last 5YR Sales (ttmvs. prior ttm ) EPS last 5YR EPS (ttmvs. prior ttm ) 17.18% 9.34% 31.81% 7.67% Industry 12.02% 7.43% 2.73% 7.76% Peer Avg. 10.69% 9.29% 21.85% 9.34% ANF 18.63% 13.01% 21.85% 13.94% GPS 1.75% -1.00% 15.03% 13.91% JCG 11.68% 15.85% 0.17%

Am erican E g H a le istorica T l rends

AEO 2007 Sales Growth EPS Growth 9.34% 7.67% AEO 2006 20.35% 34.92% AEO 2005 23.43% 32.63% AEO 2004 31.06% 351.85%

Sales growth has almost averaged 18% annually over the past five years. This is mainly due to rapid new store growth and generally positive same-store sales. Even though sales growth as well as EPS growth has slowed, we mainly contribute the decline to current U.S. conditions. We believe growth will return when the economy strengthens. Furthermore, although American Eagle slowed, they are still in positive territory at an extremely turbulent time for consumer discretionary. Growth Rating: weak

VALUATION ANALYSIS
Am erica E g vsCom n a le petitiors
AEO P/E (ttm ) P/B (m rq) P/S (ttm ) P/CF (ttm ) 9.27 2.58 1.14 7.44 Industry 18.19 4.72 1.19 12.27 Peer Avg. 21.23 8.71 1.52 14.54 ANF 14.16 3.94 1.70 10.02 GPs 18.18 3.24 0.88 12.18 JCG 28.29 18.94 1.99 21.43

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Am ericanEag H le istorica Trends l

Current P/E P/B P/S P/CF 9.27 2.58 1.14 7.44 5 Yr Avg 14.31 3.68 1.80 9.19 AEO 2007 12.92 3.59 1.66 10.95 AEO 2006 18.99 5.04 2.57 9.59 AEO 2005 13.78 3.33 1.70 8.49 AEO 2004 16.61 3.84 1.91 9.50

As you can see through the P/E graph below, the company has never been valued so cheaply on a P/E basis in the past 5 years. This obviously shows the pessimism that is associated with the company at this time and presents tremendous opportunity for multiple expansion.

Compared to peers and five year averages, American Eagle is clearly trading at severe discount on all multiples. It is reasonable that the market is trading AEO at a discount to its historical averages, but not to the severity that the company is discounted. A 54% discount from its historical P/E is one example showing the severity of the discount. The price to book ratio also shows the massive discount AEO is currently trading. With AEOs 5 year average equivalent to competitors current P/B, it is trading at a 43% discount to its competitors and 5 year average while maintaining equal or better margins and returns. Value Rating: Very Good

Consumer Preferences
AEO sells cheaper merchandise then its toughest rivals ANF and JCG. With less money teens will still shop, but it is more likely that they will search for more attractive prices. They offer lower prices for similar quality merchandise then J. Crew or Abercrombie. Gap also offers better value but does not have the fashion appeal or growth potential that AEO exhibits. Researching an online chat room we asked some kids where the best bargains are when they have less money. American Eagle is definitely cheaper than Abercrombie & Fitch. I think the highest AE jeans are like 68 dollars and the highest Abercrombie & Fitch jeans are 89.50. Also in 2007 a survey done by teen Research unlimited on the Coolest Brand showed that kids 12-17 prefer American Eagle second only to Nike.12 Last Fall analysts from Piper Jaffrey visited malls in eight different cities around America and surveyed a total of 1000 teens age 12-19. The results are as follows13
12 13

Teenresearch.com answer@yahoo.com

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P p r Jafre T e C th gS rv y ip e f y e n lo in u e R k an s 1 2 3 4
5

Fall 20 07 H olliste r W st C e oast B ds ran A e m rican E le ag A rcrom & F be bie itch

F orev 2 er 1

% otal S T pring 2 007 14 13 10 8

6

% otal T 13 11 9 8
6

Fall 2 006 H olliste r We C st oast B rands A e m ricanE le ag A rcrom & F be bie itch
F orev 2 er 1

% otal T 14 12 8 8
4

H olliste r A e m rican E le ag W st C e oast B rand s A rcrom &Fitch be bie

Forev 21 er

14

As you can see American Eagle has remained one of the most popular brands over the last couple years. More importantly it is favored over Abercrombies core brand. However, it is less attractive then Abercrombie owned Hollister brand. Additionally, in the turbulent years 2001-2003 same store sales at Abercrombie decreased by an average of 7.7% compared to only 2.9% at American Eagle. During that same period GAP was also down 3% and J. Crew was down 7.2%.

S m So eS le 2 0 -2 0 a e t r a s 01 03
2001 AO E JG C G PS AF N 2.30% -10.50% -13.00% -9.00% 2002 -4.30% -14.10% -3.00% -5.00% 2003 -6.60% 2.90% 7.00% -9.00% Av rage e -2 7 .8 % -7 3 .2 % -3 0 .0 % -7 7 .6 %
15

We believe the part of the outperformance by Gap and American Eagle is due to their bias towards value for their merchandise. As of now the market is pricing American Eagle as if they should underperform their peers when in reality they will do the opposite leading to multiple expansion. It is also important to look at recent Comps over the last few months and their respective expectations. These are seen below

S m So eL s 5M n h a e t r at ots
Marc h AO E AN F G PS -1 2 -1 0 -1 8 Fe ruary b -4 -2 -6 Janu ary -7 0 -2 Dcme ee b r -2 -2 -6 N e be ov m r 0 2 -1 Av rage e -5 -24 . -66 .
16

From these figures our thesis seems distorted. Abercrombie has been outperforming American Eagle and GAP over the last five months. The good news is that the level of underperformance is more then priced into the stock and in February and March, AEO seems to be closing the gap on Abercrombie. We expect the first part of this year to be difficult for retailers but looking at surveys, historical precedence, and the merchandise prices, we remain confident that AEO will begin to expand to multiples more in-line with their peers.

14 15

Piper Jaffrey Teen Clothing Survey AEO, ANF, JGC, GPS 2003, 2002, 2001 10-K 16 Yahoo.com

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PRO-FORMA INCOME STATEMENT17,18

American Eagle Pro-Forma Income Statement Six Year Forecast for Years Ending 12/31 (in Millions, except EPS figures)
Actual 2007 Sales Grow th Projected 2008 5.00% Forecast 2009 1 5.00% Forecast 2001 0 1 5.00% Forecast 201 1 1 2.50% Forecast 201 2 1 0.00% Forecast 201 3 1 0.00% % of Revenues

Revenue

3,055.42

3,208.1 9

3,689.42

4,242.83

4,773.1 9

5,250.51

5,775.56

Operating Ex penses Cost of Revenue Gross P rofit S,G& Ex A penses Depreciation 1 ,632.00 1 ,423.42 71 5.00 1 09.00 1 ,764.51 1 ,443.69 769.97 1 28.33 1 ,992.29 1 ,697.1 3 867.01 1 47.58 2,248.70 1 ,994.1 3 997.07 1 69.71 2,529.79 2,243.40 1 21 ,1 .70 1 90.93 2,782.77 2,467.74 1 ,233.87 21 0.02 3,061 .04 2,71 4.51 1 ,357.26 231 .02 23.50% 4.00% 53.00%

Operating Income (EBIT)

599.42

545.39

682.54

827.35

930.77

1 ,023.85

1 26.23 ,1

Non-Operating Income &Ex penses Other Revenue 38.00 32.08 36.89 42.43 47.73 52.51 57.76 1 .00%

Incom Before Tax e es

637.42

577.47

71 9.44

869.78

978.50

1 ,076.35

1 83.99 ,1

Income Tax 37.5% es

236.00

21 6.55

269.79

326.1 7

366.94

403.63

444.00

37.50%

Net Income

401 .42

360.92

449.65

543.61

61.56 1

672.72

739.99

W eighted Average Shares

220.1 0

207.40

1 99.00

1 89.00

1 84.00

1 84.00

1 84.00

Earnings P er Share

1 .82

1 .74

2.26

2.88

3.32

3.66

4.02

Revenue Forecasts- This is a function of AEOs ability to grow comparable same store sales and the expansion of their store base. For the projection of revenues we looked at the companys performance during the last recession, more specifically the years 2002 and 2003 where the company struggled with Comps. During these years the company expanded their store base by 11% and 12% respectively while growth dropped to 8% and 5% respectively. For 2007 growth also dropped to a level of 9% while store openings increased 8%. Comps were also up only 1% last year which is similar to the decline in 2002. Additionally, the company is expected to open 135 new stores this year. This aggressive approach should help keep sales growth at a higher level then we saw in 2003 even though we expect same store sales to be dismal. Due to this we would estimate sales growth of 5% for 2008 keeping in mind there is a slight possibility that the company does not open as many stores as planned. Such growth may be a little conservative for 2008 but going forward we estimate a recovery to 15% growth which is a discount to the 17% average. We believe a healthier economy, more store openings and strong growth will foster this. The continued success at Aerie could be a major asset in that respect. Beginning in 2011 we should start to see growth slowing as the market becomes increasingly saturated and American
17 18

American Eagle Outfitters 2007 10-K Reuters.com 19 Data from Financial Statements from Reuters, 2007 10-K

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Eagle slows its expansion process. Once again, these figures could be conservative with continued success at Aerie. 20 Cost of Revenue- The drivers of COGS for AEO are primarily merchandising margins and costs related to rent and distribution. In the most recent conference call management indicated deterioration in these due to an increase of markdowns in the current retail environment. Also, delivery costs and fixed costs like rent are expected to be higher due to lower sales volume which will increase ATC. Over the past four years GP has been 47% on the average. During the last recession there was a couple percentage point drop as management has indicated they expect for the next year. As a result we are forecasting a 45% margin for 2008 and 46% for 2009. By 2010 we expect an increase back to 47%. Management indicated that they are improving inventory management with a new supply chain system as well. Inventory was down 5% last quarter, which should positively affect markdowns as merchandise spends less time on the shelf.21,22 SGA- For American Eagle these costs are driven by incentive compensation and supplies expense as well as professional fees and advertising. During the last year the latter decreased while the former increased. The result was that as a percent of sales SGA expenses decreased by 40 basis points. This is promising considering the increase in advertising associated with the higher growth of Aerie which allowed them to leverage total SGA expenses. We are estimating that the challenging environment will increase these margins by about 60 basis points for 2008. However, we see a return back to about 23.5% for the remaining years which is consistent with the last few years.23 Depreciation- Over the past five years depreciation has averaged 3.6% of sales. With an aggressive expansionary and remodeling program depreciation expense should continue to grow due to an increase in expenditures. We see 4% as a more reasonable number to stay conservative in our estimates.24 Other Revenue- These costs stem from revenue from gift cards, exchange rates and interest off investments. Over the last three years the company has seen this average about 1% of sales. Tax Rate- According to the 2008 conference call management expects a tax rate of 38% for the next quarter while the annual report calls for a 37% rate. We decided to average the two. Shares- Currently management is allowed to purchase 41 million shares through 2010 after purchasing 17 million in the last year. Because of short term liquidity issues it seems they will most likely wait till the 4th quarter of 2008 and purchase around 5 million of those shares. We assumed that they would purchase an additional 10 million in each of the next two years leaving 5 of the total 58 million outstanding to stay conservative. Keep in mind these are purchased throughout the year so they have a smaller effect on weighted average shares for each forecasted period.

PEER BASKET VALUATION25

20 21

American Eagle Outfitters 2007, 2006, 2005, 2004, 2003, 2002 10-K American Eagle Outfitters 2007, 2006, 2005, 2004, 2003, 2002 10-K 22 American Eagle Outfitters 2007 Earnings Call Transcript 23 American Eagle Outfitters 2007 Earnings Call Transcript 24 Reuters.com 25 Reuters.com, Fidelity.com

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AO E Trailing P/E (TTM) Forward P/E P/B (mrq) P/S (TTM) EV/EBITDA (TTM) PEG (5 yr expected) 9.27 9.6 2.58 1.14 4.63 0.67

B se A g akt v . 20.21 17.03 3.59 1.52 10.05 1.20

A NF 14.16 12.82 3.94 1.7 7.03 0.9

G PS 18.18 15.06 3.24 0.88 7.99 1.41

JC G 28.29 23.2 18.94 1.99 15.13 1.28

These peer group relative multiples indicate that in every measure AEO is undervalued relative to its peers. For the sake of relative valuation we ignored JCG excessive P/B ratio. From this it is clear the market has a very negative view of the company. A view we believe is overdone.
AE O T railingP/E(T M) T Forw P/E ard P/B(m rq) P/S(T M) T E /E IT A(T M) V B D T PE (5 y e pe d) G r x cte PE (Our 5y e pe d) G r x cte R lativ V e e alue 9.27 9 .6 2.58 1.14 4.63 0.67 0.65 B k t Av as e g. 2.1 02 1.3 70 35 .9 15 .2 1.5 00 12 .0 12 .0 Price 16.75 16.75 16.75 16.75 16.75 16.75 16.75 R lativ V e e aluePric e 36 .52 29 .71 23 .31 22 .33 36 .36 30 .00 30 .92 30 .53 We ight 10 .00% 25 .00% 10 .00% 10 .00% 20 .00% 12 .50% 12 .50%

The peer basket relative valuation allows us to find the value of American Eagle if it was priced similarly to its peers regarding various multiples. Our next step was to weight these relative valuations to arrive at a weighted average relative value target price. We chose to weight earnings the heaviest of any factor, at 35%, with an emphasis on the forward P/E ratio; we feel that since the market is forward-looking this is the best relative price multiple. Insight from analysts indicates that EV/EBITDA is considered to be an important measure within the industry so we weighted it at 20%. We saw P/B and P/S as equally relevant but below the other indicators. PEG is an extremely important factor in the retail industry as some of these companies have great growth potential and therefore deserve higher multiples. We decided to do two weightings in respect to this measure. One used our five year growth rate from our pro-forma while the other is a consensus number we received from fidelity. As you can see we are more optimistic about growth by 68 basis points over the next five years looking at our two PEGs relative to our EPS projections. Both are weighted equally and add up to 25% of the total. Relative values for AEO from $22 to $36. Our weighted avg. relative value target price for AEO is $30.53, nearly 100% upside. With AEO trading at a significant discount in almost every valuation multiple it seems that the market is projecting meager growth. The company trades at 9.6x our 2008 EPS and 7.4x 2009 EPS. With the average F/PE over the last five years being 15.1 there appears to be plenty of room for multiple expansion if the market is wrong.26 In the last five years normalized EPS growth has been about 22% on average giving it a hypothetical PEG of 0.68. Using this PEG and our projected earnings we see that the market is predicting 14.02% growth in EPS over the next five years. If we apply that PEG to the 14.7% expected growth based on our pro-forma multiple expansion gives us a new F/PE of 9.96 and when we multiply that by our projected 2008 EPS we get a value of $17.39, which is slightly above where the price is today. Keep in mind our hypothetical PEG is based off real earnings growth and not projected so it is not concrete in that respect. It seems strange for the market to discount the companys growth to such an extreme
26

Bear Stearns Report

Page 14 of 22

degree. If we apply the same PEG as Abercrombie we get a new F/PE of 13.23 and a price of $23.02. If we apply our projected EPS to the average five year F/PE of 15.1 we get a value of 26.27. Obviously the market believes that there is high degree of risk to AEO in the current environment. Our worst case relative valuation offers no downside risk at all. The company and its competitors are trading at attractive PEG and F/PE ratios. What sets AEO apart is the better value of its merchandise.

FCFF ANALYSIS 27

American Eagle FCFF (EBIT Approach) (in Millions)

Actual 2007 Sales Grow th Forecast 2008 5.00% Forecast 2009 1 5.00% Forecast 201 0 1 5.00% Forecast 201 1 1 2.50% Forecast 201 2 1 0.00% Forecast 201 3 1 0.00% Terminal Value 5.00%

Revenue Operating Income (EBIT) Operating Incom Net Tax e Add: Depreciation Less: Increm ental Fix Capital ed Less: Increm ental W orking Capital FCFF PV (FCFF)

3,055.42 637.42 401 .42 1 09.00 250.00 -1 35.00 395.42

3,208.1 9 577.47 360.92 1 28.33 267.50 45.83 1 75.92 1 56.84

3,689.42 71 9.41 449.63 1 47.58 298.36 1 44.37 1 54.48 1 22.80

4,242.83 869.78 543.61 1 69.71 343.1 2 1 66.02 204.1 9 1 44.71

4,773.1 9 978.50 61.56 1 1 90.93 328.82 1 1 59.1 31 4.56 1 98.77

5,250.51 1 ,076.35 672.72 21 0.02 295.94 1 43.20 443.61 249.92

5775.56 1 83.99 ,1 739.99 231 .02 325.53 1 57.52 487.97 245.1 1 7,1 55.98 3,594.52 62.50% 4.00%

-0.1 2

0.32

0.54 0.25

0.41

0.1 0

0.25

Terminal Value PV Terminal Value PV of Cash Flows Total Firm Value Subtract: BV (Debt) Add: Cash/Cur Firm Value Shares (208 Mil) $

7155.98 3594.52 1118.16 4712.68 0.00 116.00 4828.68 23.21

Sales Growth/EBIT/Depreciation/Tax Rate- See pro-forma Incremental Fixed Capital- A growing retail business is very capital intensive. American Eagle is committed to growing their store base, remodeling existing stores, investments in IT and building better distribution centers. These are the areas that seem to consistently drive their investment in fixed capital. In last quarters conference call management called for expenditures in the range of
27 28

American Eagle Outfitters 2007, 2006, 2005, 2004, 2003, 2002 10-K Data from Financial Statements from Reuters,

Page 15 of 22

$250-$270 million next year. Approximately $37 million should be related to the completion of a new corporate headquarters and a distribution center in Kansas to improve logistics. The project began in 2006 and we did not factor it into our calculation of fixed capital investment because although a business expense, it is not a consistent expenditure. By this we mean it is not distribution maintenance, IT maintenance, or store maintenance. Therefore it is not as relevant for forecasting purposes because we do not expect another expense of this nature within our forecasted period. We are including store expansion because management has made it clear that this should continue throughout our forecasted period. Additionally, there was a $14 million purchase of a corporate jet last year which is irrelevant, although concerning as potential investors. By normalizing expenditures over the last eight years we found expenditures to be about 62% of the change in sales. 29 Incremental Working Capital- To calculate this we looked at the eight year average change in working capital relative to change in sales. We wanted to look at eight years because that incorporates an entire business cycle. Our calculation was that investment in working capital is about 30% of sales. We decided to ignore two years because of outliers. One was due to extremely weak sales growth which we do not expect in our forecasted period. Inventory had got to the point where it was 63% of the working capital. In slow-downs it is extremely important for retailers to manage their inventory. After a buildup to 393 million in inventory in the third quarter, strong efforts have been made to reduce the 4th quarter inventory down to 286 million. Management is committed to controlling this issue. Last year there was a rare decrease in working capital due to a decrease in investments and an increased cash position. There is no reason to believe a trend like this should continue as the company is very committed to growing its business. Although the possibility exists that this could happen again, we want to remain conservative. Discount Rate- To calculate our discount rate we used WACC. For the cost of equity we used the CAPM model. The risk free rate came from the 30-year treasury (3.54%) and the market premium was 6.73%. Using a beta of 1.28 gave us a cost of equity of 12.16%. Since the company is completely financed by equity this is our WACC.30

THREE-STAGE WITH DECLINING GROWTH IN STAGE TWO

We also did a valuation using a three-stage model with declining growth in the second stage. For this we made the same assumptions for WACC that we did in our FCFF model. The model assumes a 25.00% growth in FCF through 2013 and a gradual drop off to 5% growth for the next five years. The 25.00% is the average growth of FCF in our FCFF valuation model. The original H-model looks like this V= FCF(1+Gl) + FCF*H(Gs-Gl)/(r-Gl) Due to the fact we are starting our linear decline in 2014 our model looks like this V= All discounted cash flows through 2014 from our FCFF model (1118.15) + (487.97*(1.05) + 487.97*2.5*(0.25-0.05))/(0.1216-0.05) This gave us a value of $5,038. From this we must add back cash (116) and divide by the shares outstanding. This gives us a value of $24.78 per share which is slightly above our FCFF valuation.

29 30

American Eagle Outfitters 2007 Earnings Call Bloomberg

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T reeS g W D lin Grow inS g T o h ta e ith ec ing th ta e w

2008 FCF Discounted Flows As um tion s p s WACC- 12.16% Stage 1- 25% Stage 2,3 - 25% -5% Stage 3 -5% 175.92 156.84 2009 154.48 122.8 2010 204.19 144.71 2011 314.56 198.77 1118.15 3919.98 116 208 $ 24.78 2012 443.61 249.92 2013 487.97 245.11

Discounted Flows Through 2013 Add: H-m odel Value Add:Cash Shares Value

SUMMARY
American Eagle is cheap based on our relative valuation, FCFF valuation, and Three-Staged model. Even our worse case valuation using a hypothetical PEG offers 10% upside based on todays closing price of $15.80. Our relative valuation gives us a price target of $30.53 which is nearly double the current price. On a cash flow basis the company seems more expensive and gave us a value of about $24 based on the two models we used. Even this is 51% upside based on the current price. Taking these valuations into consideration and the price based off the five year average F/PE we believe in a price target from about $24-$27 if we are right about our thesis. However, since we realize there is a certain degree of risk, we feel a price target of $21 $22 to be appropriate. If AEO takes market share away from its more expensive competitors and continues to see modest growth in its Aerie brand while controlling cost to a degree the shares should easily hit our PT. Risks include incorrect assumptions about AEO outperforming its peers. Additionally, if we go into a severe consumer recession the company will be affected accordingly. In both of these scenarios we still believe the shares to be 0%-10% undervalued. In essence, everything short of a retailing disaster is priced into the stock making it extremely attractive on a risk/reward basis. For the company to trade at its historical F/PE EPS for 2008 would need to fall to $1.08 compared to $1.81 last year. With all the pessimism and short interest (6%) there should be plenty of buyers out there and we recommend a long-term buy.

Luke Parkhurst Drew Swanson Matt Unger

April 15, 2008

Annual Income Statement

Page 17 of 22

2008 In Millions of U.S. Dollars (except for per share items) Total Revenue Cost of Revenue, Total Sell/General/Admin. Expenses,Total Depreciation/Amortization Total Operating Expense Operating Income Other, Net Net Income Before Taxes Provision for Income Taxes Net Income After Taxes Net Income Before Extra. Items Total Extraordinary Items Net Income Income Available to Common Excl. Extra. Items Income Available to Common Incl. Extra. Items Basic/Primary Weighted Average Shares Basic/Primary EPS Excl. Extra. Items Basic/Primary EPS Incl. Extra. Items Dilution Adjustment Diluted Weighted Average Shares Diluted EPS Excl. Extra. Items Diluted EPS Incl. Extra. Items DPS - Common Stock Primary Issue Gross Dividend - Common Stock Stock Based Compensation Pro Forma Net Income Pro Forma Basic EPS Pro Forma Diluted EPS Depreciation, Supplemental 3,055 1,632 715 109 2,457 599 38 636 236 400 400 0 400 400 400 216 1.851 1.851 -220 1.816 1.816 0.38 81 ----109

2007

2006
Reclassified 03/02/07

2005

2004
Restated 01/29/05

02/02/08 02/03/07

01/28/06 01/29/05 01/31/04

2,794 1,454 666 88 2,208 587 42 629 242 387 387 0 387 387 387 223 1.740 1.740 -228 1.696 1.696 0.28 62 ----88

2,322 1,244 540 79 1,863 459 18 477 183 294 294 0 294 294 294 227 1.292 1.294 -233 1.260 1.262 0.18 42 ----77

1,881 1,003 447 68 1,519 363 4 367 143 224 224 (11) 213 224 213 218 1.030 0.980 0.0 225 0.995 0.947 0.04 9 10 204 0.933 0.907 66

1,435 886 356 60 1,302 133 2 135 52 83 83 (23) 60 83 60 213 0.390 0.279 0.0 217 0.384 0.275 0.00 0 14 46 0.213 0.213 59

Normalized Income Before Tax Inc Tax Ex Impact of Sp Items Normalized Income After Tax Normalized Inc Avail to Common Basic Normalized EPS Diluted Normalized EPS

636 236 400 400 1.851 1.816

629 242 387 387 1.740 1.696

477 183 294 294 1.292 1.260

367 143 224

135 52 83

Page 18 of 22 224 83
1.030 0.995 0.390 0.384

Annual Balance Sheet

Page 19 of 22

2008 In Millions of U.S. Dollars (except for per share items) Cash & Equivalents Short Term Investments Cash and Short Term Investments Total Receivables, Net Total Inventory Prepaid Expenses Deferred Income Tax Other Current Assets Other Curr. Assets, Total Total Current Assets Buildings Land/Improvements Machinery/Equipment Construction in Progress Leases Property/Plant/Equipment - Gross Accumulated Depreciation Property/Plant/Equipment - Net Goodwill, Net Long Term Investments Other Long Term Assets Total Assets Accounts Payable Accrued Expenses Notes Payable/Short Term Debt Curr. Port. LT Dbt/Cap Ls. Income Taxes Payable Other Current Liabilities Other Current Liabilities, Total Total Current Liabilities Total Long Term Debt Total Debt Deferred Income Tax Other Liabilities, Total Total Liabilities Common Stock Additional Paid-In Capital Retained Earnings (Accumulated Deficit) Treasury Stock - Common Other Equity, Total Total Equity Total Liabilities & Shareholders Equity Total Common Shares Outstanding Trsy. Shrs-Comm. Primary Iss. 116 504 620 32 286 35 47 -47 1,021 107 7 428 22 528 1,091 (466) 626 11 166 20 1,868 158 166 0 -23 29 52 376 0 0 45 106 527 2 493 1,602 (793) 35 1,340 1,868 204 44

2007
Restated 02/02/08

2006
Reclassified 02/03/07

2005
Restated 01/28/06

2004 01/31/04
Restated 01/29/05

02/02/08 02/03/07

01/28/06 01/29/05

60 754 814 26 264 34 52 -52 1,189 34 7 290 92 435 858 (376) 482 10 265 16 1,980 171 170 0 -92 31 123 465 0 0 0 98 562 2 453 1,302 (363) 22 1,417 1,980 221 26

131 621 752 29 211 30 43 12 55 1,077 31 4 239 1 392 667 (322) 346 10 146 28 1,606 139 144 0 -43 25 69 351 0 0 -99 450 2 370 979 (217) 21 1,156 1,606 222 21

219 370 590 26 171 26 39 14 53 865 30 3 209 2 358 603 (264) 340 10 84 29 1,329 109 114 0 -34 26 60 283 0 0 -83 365 2 268 727 (45) 12 963 226 9

137 201 338 24 121 28 21 -21 531 21 2 187 2 354 567 (226) 341 10 24 26 932 71 81 0 5 29 23 52 209 14 19 -72 295 1 157 522 (45) 3 637 224 11

Page 20 of 932 22 1,329

Annual Cash Flow Statement

2008 In Millions of U.S. Dollars (except for per share items) Net Income Depreciation/Depletion Deferred Taxes Discontinued Operations Unusual Items Other Non-Cash Items Non-Cash Items Cash Taxes Pd, Supplemental Cash Interest Pd, Suppl Accounts Receivable Inventories Prepaid Expenses Accounts Payable Accrued Expenses Changes in Working Capital Total Cash from Operations Capital Expenditures Sale of Fixed Assets Sale/Maturity of Investment Purchase of Investments Other Investing Cash Flow Other Investment Cash Flow Items, Total Total Cash from Investing Financing Cash Flow Items Total Cash Dividends Paid Common Stock, Net Options Exercised Issuance (Retirement) of Stock, Net Long Term Debt Issued Long Term Debt Reduction Iss (Retirmnt) of Debt, Net Total Cash From Financing 400 109 (8) 0 1 36 37 261 0 (6) (19) (1) (16) (33) (73) 464 (250) 0 2,127 (1,773) (1) 353 103 6 (81) (451) 13 (437) 0 (2) (2) (514) 387 88 (28) 0 184 42 226 204 0 3 (54) (4) 32 90 75 749 (226) 12 916 (1,353) 0 (425) (651) 19 (62) (154) 28 (126) 2 (3) (1) (169) 2007 2006 01/28/06
02/03/07

2005

2004
Restated 04/06/06

02/02/08 02/03/07

01/29/05 01/31/04
02/03/07

Reclassified Reclassified

294 79 5 (15) 1 55 41 133 0 5 (39) (4) 29 53 47 466 (82) 0 876 (1,188) 0 (312) (393) 0 (42) (171) 48 (123) -(1) (1) (166)

213 69 (17) 20 1 54 76 121 1 4 (45) 2 23 49 37 378 (97) 0 330 (509) 0 (178) (276) -(9) 0 58 58 -(20) (20) 29

60 60 13 12 -8 20 25 2 (9) 7 3 21 24 51 204 (78) -246 (398) (2) (153) (231) -0 (1) 1 0 -(5) (5) (5)

Page 21 of 22

Foreign Exchange Effects Net Change in Cash Net Cash - Begin Balance/Rsvd for Future Use Net Cash - End Balance/Rsrv for Future Use Depreciation, Supplemental Cash Interest Pd, Suppl Cash Taxes Pd, Supplemental

3 56 60 116 109 0 261

0 (71) 131 60 88 0 204

5 (89) 219 131 79 0 133

2 133 86 219 69 1 121

1 (31) 117 86 60 2 25

Page 22 of 22