1. American Eagle Outfitters (AEOS) Dan DeRose Matthew McDonnell 14-November-2006

2. Presentation Outline Company overview RCMP Position Macroeconomic/Market overview Industry overview –Porter’s 5 forces Firm strategy/development Stock performance Portfolio “fit” Firm financial performance –Historical cycles and margin analysis –Relative ratio analysis –DuPont Decomposition Valuation –Margin, ratio & multiple analysis –Discounted cash flow (DCF) Recommendation

3. Part 1: Company overview

4. American Eagle Outfitters- The Business Business: Specialty clothing retail Product: Casual clothing (tops, bottoms), intimates, footwear, outerwear, accessories, and fragrances Target customers: –AEOS= 15-25yrs –Martin + Osa= 25-40 Venues: Primarily mall-based stores with limited stand- alone stores and internet sales Geography: –Stores in all 50 states, Puerto Rico, and Canada –Limited online sales to locations outside USA

5. Company Overview 1994: –Incorporated as Natco Industries Inc. 1999: – Adopts present name 2000: – Bought 3 Canadian businesses Thriftys/Bluenotes, Braemar, National Logistic Services 3-2 Stock spit 2004: –Thriftys/Bluenotes sold –2-1 Stock split –First ever dividends paid 2005: –Announces launch of Martin + Osa, Arie –Dividends raised 2006: – Much of National Logistic Services

6. Part 2: RCMP Position

7. RCMP Position Transaction history –10-Dec-1999: BOT 200 shares at $44.00 –10-Jan-2000: BOT 200 shares at $27.00 –3-May-2000: BOT 600 shares at $15.63 –23-Feb-2001: 3-2 split –8-Mar-2005: 2-1 split –25-Apr-2005 SLD 600 shares at $26.28 –16-Nov-2005 SLD 700 shares at $23.33

8. RCMP Position Gains/losses –Book value of holdings= $13,504 –Realized capital gains= $21,842 –Unrealized capital gains= $ 65,454 –Market value of holdings= $ 78,778 Portion of portfolio MV= 22.70%

9. Part 3: Macroeconomic and Market Overview

10. Macroeconomic/Market Overview Macroeconomic overview –Economic growth in Q2, Q3 2006 lower versus previous year

11. Macroeconomic/Market Overview Consumption spending –Weak y/y summer –Strong y/y fall

12. Clothing and shoe spending steady since 2003 2006 Q1, Q3 stronger y/y, 2006 Q2 significantly weaker Macroeconomic/Market Overview

13. Clothing and shoe spending very non-cyclical –Although we do not have data for specialty clothing retailers such as AEOS, we would likely expect much more sensitivity to changes in real GDP growth

14. Part 4: Industry Overview

15. Industry Overview- Specialty Clothing Retailers Overall Threat Level: High Threat of new entrants HIGH Power of Suppliers LOW Threat of Substitutes LOW Industry Rivalry HIGH Power of Customers MODERATE

16. Part 5: Firm Strategy and Development

17. Firm strategy/development Open 45-50 stores per year Remodel and/or relocate 45-50 stores per year until all 160 stores in old format are updated –Renovated stores achieved an annual sales increase of 46% on a 29% increase in square footage Sustain momentum and position brand –Jeans became number one specialty store brand purchased – doubling market share since 2003 –Focus on knit business such as polo's, graphic Ts and tank tops

18. Firm strategy/development Product Mix –Product mix has remained constant last several years with slight shifts toward women’s apparel and accessories at the expense of men’s apparel and accessories

19. Firm strategy and development Continue to develop aerie –Sub-brand of intimates (bras, panties, dormwear, and personal care) that is consistent with the AE lifestyle –Real estate strategy consists of integrated, side-by-side, and stand-alone stores

20. Firm strategy and development Develop Martin + Osa –New brand aimed at designing sportswear for the 25-40 year old customer –Opened 4 stores in August, plan on opening 10- 15 in 2007

21. Firm strategy and development Expanding distribution centers in Kansas to support further growth of AE and Martin + Osa

22. Recently, the firm has stressed expansion into the Southwest US Firm strategy and development 2000 2002 2004 2005

23. Part 6: Stock Performance

24. Stock Performance Current Price : 47.50 52 Week Range: 19.45 – 47.48 Stock price up 203% since January 3 rd Dividends –Quarterly dividend increased to $0.113 from $0.075 in 2 nd quarter

25. Stock Performance AEOS has outperformed S&P and NASDAQ for 5 yr. and 6 mo. intervals

26. Stock Performance AEOS has outperformed competitors ANN, ANF, and LTD for 5 yr. and 6 mo. intervals

27. Part 7: Portfolio Fit

28. Portfolio Fit- Diversification AEOS, our largest holding, comprises 22% of market value of portfolio (November 7 th ) As shown in the graphs on the right, this concentration is due to high relative AEOS appreciation Our next largest holdings are JPM and FR at 13% each

29. Portfolio Fit – Correlation Matrix Note: Table assumes equal-weighted portfolio

30. Portfolio Fit – Appraisal Ratio Appraisal ratio : Risk-adjusted measure of excess returns provided by a security = alpha/(std error^2) Suggests user add (short) the security if alpha is significant and appraisal ratio is greater than alternatives

31. Portfolio Fit – Appraisal Ratio Note: All values are significant at 90% confidence Source Data: Yahoo! Finance

32. Part 9: Firm Financial Performance

33. Firm Financial Performance- Cyclicality and Margin Response As shown in the right, AEOS went through a downturn in FY 2002 and 2003 "Merchandise assortments not clearly focused on target customers" led to "higher markdowns and increased promotional activity” AEOS 2003 10-k p. 11 What was margin response? 2002: “We were also not able to leverage selling, general and administrative expenses as a result of the negative comp store sales” AEOS 2002 10-k p. 11 2003: "The decline in our gross profit margin was primarily due to the deleveraging of rent expense as a result of weak comparable store sales…” 2003 10-K p. 11

34. Firm Financial Performance- Relative Ratios Profitability Financial Strength/Liquidity

35. Financial Management- DuPont Breakdown Increases in ROE due primarily to greater profit margins (positive).

36. Part 10: Valuation

37. Valuation Method 1: Trading Multiples Step 1: Establish list of comparable firms Criteria used for choosing comparables: 1.Similar size (market cap) 2.Similar capital structure (Debt/Assets) 3.Similar dividend policy (retention rate)

38. Trading Multiples Step 2: Calculate average multiples Step 3: Apply multiples for firm being valued

39. Valuation Method 2: Discounted Cash Flow (DCF) Analysis- Base Case Step 1: Forecast FCF Step 2: Calculate WACC

40. Discounted Cash Flow (DCF) Analysis- Base Case Step 3: Calculate Terminal Value and Discount Cash Flows

41. DCF Analysis- Base Case Step 4: Subtract debt and divide by shares outstanding to arrive at intrinsic value

42. DCF Analysis- Base Case Sensitivity Analysis

43. However…

44. The DCF value just presented assumes steady annual growth of approximately 15% –Although AEOS has demonstrated an ability to grow at extremely high rates (over 15%), one cannot forget the firm’s susceptibility to shifts in consumer preference (fashion) DCF Analysis- Downside Scenario

45. Let’s assume that for whatever reason, AEOS experiences a 2-year downturn in comparable store sales similar to the one experienced in 2002-2003

46. DCF Analysis- Downside Scenario Under this downside scenario, we see that the DCF-generated stock price decreases significantly

47. DCF Analysis- Downside Scenario Sensitivity Test

48. Valuation Methods Compared

49. Part 11: Recommendation

50. Recommendation Firm direction –Martin + Osa –Margins Diversification Valuation –Trading multiples The trading multiples approach suggests a price similar to that at which AEOS is currently trading This price relies on the firm’s past sales, earnings, and free cash flow numbers and thus, would be prone to overvaluation, especially when used in a long-term investment decision –DCF Although our DCF model is somewhat crude, we feel that the insight added by accounting for a downturn in sales shows, in a very dramatic way, the downside risk inherent in the company In summary, we believe that American Eagle Outfitters’ strong performance in recent periods has caused unrealistic market expectations for the firm’s future performance, thus inflating the price

51. Recommendation Our recommendation, therefore is to sell approximately 24% or 400 shares of AEOS at the market –Realized capital gain approx.= $15,664

52. Questions?