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The Three As: Promotional Battle in Teen Retailers

12/6/2013
Companies mentioned:

American Eagle Outfitters (AEO) - $15.96
Abercrombie & Fitch (ANF) - $35.70
Aeropostale (ARO) - $9.17

Why Read?

Investors are increasingly concerned that Teen Retailers, in particular American Eagle Outfitter
(AEO), Abercrombie & Fitch (ANF), and Aeropostale (ARO), are eroding long-term profitability
through increased promotions in an attempt to restore growth to anemic comparable store sales and
control market share.
_________________________________________________________________________________________________________

! Comparable store sales trending down: All of the Three As have reported negative
comparable store sales in each quarter during FY2013. ANF and ARO have reported
significantly worse comparable store sales results than AEO. Since 1Q08, AEO has reported
positive comparable store sales in just 9 out of the last 23 quarters (ANF: 7/23, ARO: 12/23).

! Promotions trending negative: Retailers have encouraged sales through increased
promotional activity. Weekly channel checks show that retailers have increased the cadence of
promotions YoY beginning significantly in 2Q13. We expect this trend to continue as retailers
dial down expectations after a lackluster beginning to the holiday shopping period.

! Margin sacrifice: With consumer confidence still weak, lagging employment gains, and the
bifurcation of the middle-class consumer between low-price discount and high-end luxury
retailers; traditional brick and mortar retailers are now operating in a world where investors
prize market share over profitability.
*Bianus Incluueu: Ameiican Eagle, Aeiie, Abeiciombie, Abeiciombie kius, Bollistei, Aeiopostale.
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2
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Since 1Q12, the three As have all had down-trending comparable store sales results and negative results
in YTD13. This has been the result of changing consumer preferences in the teen space, a shaky
economy driving promotional activity in the space, and growing pains from transitioning to Omni-
channel business models.


What is most alaiming is the two-yeai compaiable stoie stack iesults. Since 4Q12, only AE0 has
been able to consistently cieate positive compaiable sales on a 2-yeai basis. Inteiestingly,
sequentially AR0 was the only company of the thiee to iepoit a uecline in compaiable stoie sales
on a 2-yeai stack basis fiom 2Q1S to SQ1S. Peihaps Emilia Fabiicant hiie anu bianu's tiansition to
a moie fashion heavy piouuct mix has been less successful than claimeu.
Comparable Store Sales Two
Year Stack Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013
AEO
15.0% 15.0%
12.0%
2.0% 5.0%
ANF
4.0% -1.0% -20.0% -20.0% -17.0%
ARO
-8.0% -18.0% -12.0% -15.0% -16.0%
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AE0
ANF
AR0

S

0n a thiee-yeai stackeu basis, once again, AE0 is a cleai winnei in cieating compaiable stoie gains
while ANF has continueu to stiuggle, especially in its Bollistei concept. Neanwhile, AR0 has
continueu to show that the bottom has yet to aiiive with the oveiall tienu still cleaily negative.

!"#$#%&#'. <",'=&'> 4,>(%&-,/

Nota Bene: Each week we perform channel checks tracking promotional levels. While these checks are based on a
limited sample size, we believe they offer investors valuable insight in tracking promotional cadence with less
promotional retailers more likely to be above plan compared to those with increasing promotional levels.
Additionally, we believe that intra-quarter sequential promotional trends offer further insight, favoring retailers
which trend promotionally less through the quarter and are wary of retailers who heavily markdown into the end
of the quarter to make the comp.

*Bianus Incluueu: Ameiican Eagle, Aeiie, Abeiciombie, Abeiciombie kius, Bollistei, Aeiopostale

We believe traffic and conversion has likely returned to challenging levels, similar to late 2Q13 as the
trend has strengthened into 3Q13. Compared to 3Q12, we highlight the lack of incremental newness in
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AE0
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4
fashion while Teen Retailers continue to focus on transitioning to a greater fashion mix as they
experiment with new lines (ARO fashion forward BTS launch). In 2H12, incremental conversion was
driven by new fashion such as colored denim (strongest at ANF). As we move from BTS solidly into the
Holiday Season, many retailers are focusing on more neutral tones and basics while try to recapture
incremental customers.

Weakening transaction and traffic are driving comparable store sales weakness in 2H13 despite a highly
competitive promotional environment. In 2Q13, AEO and ARO reported -3.0% and -10.0% declines in
transactions, respectively. Commentary from management highlights weakening traffic across the mall,
on AEO 2Q13 conference call, management stated,

Store traffic in North America was uneven throughout the quarter and further decelerated in July.
These factors led to deeper and broader promotions, directly resulting in increased markdowns, which
pressured second quarter earnings. AEO 2Q13 conference call


American Eagle Outfitters

American Eagle, along with its peers has shifted
towards more promotional activity to drive traffic.
We expect AEO Black Friday and early Holiday
Season shopping sales to be weak. This year AEO ran
50% off everything on Cyber Monday vs. 40% off
everything last year. Additionally they have extended
the offer into the first week of December, often
indicative that further promotions are necessary to
meet sales expectations for Q413. We expect AEOs
markdown and promotional cadence to continue to
accelerate through the Holiday shopping season.

Abercrombie & Fitch

Abercrombie

In line with its peeis, Abeiciombie has incieaseu
its piomotional activity vs. LY, incieasing in
cauence as the yeai has piogiesseu. We expect
Abeiciombie Black Fiiuay anu eaily Boliuay
season shopping sales to be weak. This yeai
Abeiciombie ian Su% off eveiything online on
Cybei Nonuay vs. 4u% off eveiything last yeai.
0nlike AE0, Abeiciombie has tapeieu the
piomotion as the week has piogiesseu, cutting the
piomotion to 4u% off eveiything online on
Weunesuay anu uiscontinuing the piomotion on
Thuisuay Bec. S
th
.


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abercrombie kids

In line with its peeis, abeiciombie kius has
incieaseu its piomotional activity veisus LY,
incieasing in cauence as the yeai has piogiesseu
although geneially bettei than auult Abeiciombie
stoies. We expect abeiciombie kius Black Fiiuay
anu eaily Boliuay season shopping sales have been
weakei compaieu to LY.






Hollister

In line with its peeis, Bollistei has incieaseu its
piomotional activity veisus LY, incieasing in
cauence as the yeai has piogiesseu. We expect
Bollistei Black Fiiuay anu eaily Boliuay season
shopping sales have been weak. This yeai Bollistei
ian Su% off eveiything online on Cybei Nonuay
vs. 4u% off eveiything last yeai. Auuitionally they
weie offeiing jeans fiom $2u anu up veisus $2S
anu up LY, fuithei ieinfoicing the competitive
tienu in the uenim categoiy as Teen Space
attempts to lap the benefits fiom coloieu bottoms
last yeai.

Aeropostale

As all Three As increase their promotional
competition, ARO is at the greatest risk of losing
market share to competitors. ARO has the lowest
brand cache of the three and consumers are likely to
trade up to the higher regarded AEO and ANF lines
as the incremental price differential decreases.
Despite often discounting 10% more than its
competitors we did not see an increase in transactions
in 3Q13 with transactions down -10.0% QoQ and -
8.0% on a 2-year basis. Sequentially we did see an
improvement on a 2-year basis from -14.0% to -8.0%
from 2Q13 to 3Q13 while transactions remained flat
at -10% sequentially.

(Cont. on next page)
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6
Additionally, we expect that ARO sales have been hurt as they target incremental customers with more
fashion forward BTS and holiday lines.

Margin Sacrifice:

To uemonstiate the impact of incieaseu piomotional activity in the space we have oveilaiu the
meichanuise maigin Bps impact to gioss maigin foi the companies who uisclose the metiic.


AE0's meichanuise maigin has continueu to uecline thiough the yeai has the pace of piomotions
have acceleiateu.

(Cont. on next page)

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Less Flat Noie Neichanuise Naigin Bps Change

7

AR0's meichanuise maigin has seen the most uiastic uecline thiough the yeai. Neichanuise
maigin Bps impact has been negative since 4Q12, anu significantly woise than its peeis. In SQ1S,
the company iepoiteu at (98u) Bps uecline in gioss maigin, uiiven by (69u) Bps uecline in
meichanuise maigins, loweiing the company's aujusteu gioss maigin to just 18.1%. H @&)) @"&%,
%E(% #', $#", %&$,3 IJKIL >"#.. $(">&' M#" ( .9,C&()%N ",%(&),"O This is just unheaiu of; few
companies have evei iepoiteu sub 2u% gioss maigins, even in 4Qu8. With compaiable stoie sales
expecteu to continue to uecline at the same pace as YTB iesults (-1S%), we expect meichanuise
maigins will continue to eioue into 4Q1S.

8#'C)P.&#'/
As the promotional Holiday season continues expect promotions to increase as retailers become
more aggressive in focusing on capturing market share and restoring/meeting comparable store sales
expectations all while throwing profitability on the back burner. Among the Three As: American
Eagle Outfitters, Abercrombie & Fitch, and Aeropostale, an all out war is occurring where victory can
only be claimed once there is a clear last man standing victor in market share. Each of these
companies have seen the tastes of their core customer, the middle to aspirational-middle-class teen
consumer, shift drastically over the last 5-7 years towards more fashion forward assortments and away
from the popular logo basics that drove growth through the late 1990s and early 2000s.

We expect AEO to be the clear winner this holiday season as they are the only company of the three
posting somewhat optimistic comparable store sales although we would have liked to see a greater
increase in market share in light of their competitors horrible results. They should be able to capture
even more share as this promotional environment due to the price gap between their lower-end
competitor ARO shrinking.

We expect ANF to post mixed results. While we remain optimistic about the turnaround in the main
Abercrombie and abercrombie kids concepts we still see continued erosion and delaying of expectation
for the Hollister concept.

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Less Flat Noie Neichanuise Naigin Bps Change

8
We expect ARO to continue to fall apart as they continue to post some of the worst comparable store
sales results and margin losses in specialty retail history. They have completely lost touch with their
core customer while placing no meaningful accountability on their management. CEO Tom Johnson
needs to be fired, ASAP, unless the plan is to replace him with Aeropostale EVP Emelia Fabricant
(see the wonders she did at BEBE (sarcasm)) in which case the entire board of directors should be
replaced as well. Recently shares have been bolstered by activist investor activity and the possibility of a
buy-out in play. Without these crutches, we would expect shares to be trading materially lower.






































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