Cramer's Investing Club: A deeper dive into why we bought more of this retailer before the holidays

Published Tue, Nov 23 20212:32 PM ESTUpdated Fri, Jan 14 202212:34 PM EST

(This article was sent first to members of the CNBC Investing Club with Jim Cramer. To get the real-time updates in your inbox, subscribe here .) Charitable Trust holding American Eagle Outfitters (AEO) reported stronger than expected third quarter results Tuesday morning and the shares were on the move higher Tuesday. Breaking down the numbers: Total net revenue increased 24% YoY to $1.27 billion, topping estimates of $1.23 billion (FactSet). Adjusted earnings per share of $0.76 crushed the consensus of $0.61, according to FactSet. Looking at sales, consolidated store revenue increased 29% thanks to double-digit growth in traffic, while digital revenues grew 10% and lapped a difficult 29% comp from the prior year. Both store and digital revenues and profits in the quarter exceeded levels achieved in the third quarter of 2019, a sign that the company has emerged from the pandemic in a strong position. The rise of casual wear, a trend we believe will be a multi-year story, continues to be a huge driver of sales growth at the company's two leading brands. Strongest margins in years: Company third-quarter gross margins were the strongest since 2007, expanding 410 basis points YoY to 44.3% (1 basis point equals 0.01%). This was a beat against estimates of about 42%. The increase was largely due to leverage on rent and delivery as well as strong product demand, higher full-priced sales, less promotional activity, and inventory optimization initiatives, though higher freight costs were a drag. Operating margins at 16.5% were also the strongest since 2007 and exceeded estimates of about 13.8%. Total operating income in the quarter was $210 million, representing a big beat compared to estimates of $170 million. Management said on the call that they expect operating income to "nicely exceed" $600 million this year. Breaking down the brands: By brand, Aerie's revenue increased 28% YoY to $315 million. The momentum here is simply unstoppable with the quarterly results representing the 28th consecutive quarter of double-digit growth. The company cited strong demand across the entire Aerie portfolio, with notable strength in intimates and off-line activewear. It appears that Aerie is taking market share too, as management said they are seeing customers transacting more frequently and across more categories. The AUR, or average unit retail (average selling price), increased in the high teens thanks to higher full-price selling and strategic decision-making around promotions. Aerie's operating margin of 16.5% expanded 200 bps from 2020 and hit a new third-quarter high for the brand. Aerie overcame challenges related to some unevenness of inventory flow related to factor shutdowns in South Vietnam. These shutdowns primarily impacted Aerie's high-demand legging business, which is also a high-margin category. So Aerie's margins would have been even higher if they didn't miss out on some business. At American Eagle, revenue increased 21% YoY to $941 million. Driving sales in the quarter was growth across all categories in men's while women's delivered strong results thanks in part their signature denim category. American Eagle also had a very strong back-to-school season thanks to the brand's leadership in jeans along with new product style offerings. When you hear about beneficiaries of a denim cycle, you have to include American Eagle because the company is number 1 in denim in women's for all ages and number 1 in men's for its age demographic. We also see signs that American Eagle is not the market share donor that some believe it to be. The company said on the call that its customer file is up and customers are also buying more frequently and spending more. And thanks to inventory optimization and promotional discipline, AUR grew, and merchandise margin expanded. Operating margin in the quarter was 27.8%, representing a new high for the brand. Key topics — inventory and supply chain: American Eagle Outfitters ending inventory at cost increased 32% to $740 million. The company said the increase was partially driven by higher air freight due to global supply chain disruptions, which resulted in uneven inventory flows related to factory closures in Vietnam. To ensure that their stores will have plenty of stock in time for the holidays, the company chose to air the product. All things considered, management is pleased with their inventory position ahead of what should be a very strong holiday season. Updating on everyone's favorite topic of supply chain and logistics, the company continued to effectively manage through what has been a challenging environment with little disruption outside the factory closures in Vietnam. AEO's delivery cost dollars were actually down YoY, thanks to efficiencies created in digital delivery. That being said, the company expects to incur between $70 million to $80 million of freight costs in the fourth quarter. Management also spent some time on the call discussing its recent acquisition of Quiet Logistics. During the conference call, COO Michael Rempell said the deal gives AEO "the ability to drive substantially greater sales and margin on far less inventory, create more precision in our inventory allocation decisions and deliver products to customers both faster and at a lower cost." This deal followed the acquisition of AirTerra. On the conference call, CEO Jay Schottenstein said, "we expect the combination of Quiet Logistics and the recent acquisition of AirTerra to create a unique platform that revolutionizes logistics within our business in retail." Plenty of firepower: Regarding cash, the company ended the quarter with $741 million in cash on the balance sheet. Thanks to a strong balance sheet, American Eagle Outfitters has plenty of firepower to support investment in growth initiatives and shareholder returns. At current levels, we find the 2.5% dividend yield attractive. Given cash flow, we would not rule out the possibility of share repurchase activity in the future. Bottom line: Overall, a terrific quarter for American Eagle Outfitters as the company proved to be one of the big back-to-school shopping season winners we originally thought it would be. With momentum in casual wear and activewear on its brand's side and margins running at the strongest levels in over a decade, we think the stage is set for American Eagle Outfitters to deliver this holiday season. We were puzzled earlier by how the stock was not getting any credit in the market for this strong report, explaining why we decided to add to our position this morning . What is clear from the quarter is that American Eagle Outfitters has emerged from the pandemic as a better company with the right product assortment and an exciting new logistics initiative. We think this cheap stock trading at a low teens price-to-earnings multiple and a 2.5% dividend yield is going higher. The CNBC Investing Club is now the official home to my Charitable Trust. It's the place where you can see every move we make for the portfolio and get my market insight before anyone else. The Charitable Trust and my writings are no longer affiliated with Action Alerts Plus in any way. As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Typically, Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If the trade alert is sent pre-market, Jim waits 5 minutes after the market opens before executing the trade. If the trade alert is issued with less than 45 minutes in the trading day, Jim executes the trade 5 minutes before the market closes. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. See here for the investing disclaimer . (Jim Cramer's Charitable Trust is long AEO.)

A shopper wearing a protective mask walks past a sale sign at an American Eagle Outfitters Inc. clothing store at Westfield San Francisco Centre in San Francisco, California, U.S., on Thursday, June 18, 2020.

Michael Short | Bloomberg | Getty Images

(This article was sent first to members of the CNBC Investing Club with Jim Cramer. To get the real-time updates in your inbox, subscribe here.)

Charitable Trust holding American Eagle Outfitters (AEO) reported stronger than expected third quarter results Tuesday morning and the shares were on the move higher Tuesday.