Buy American Eagle because of an 'ongoing resurgence in the denim cycle,' analyst says

KEY POINTS

• D.A. Davidson initiated coverage of American Eagle with a buy rating and a $21 price target.
• "As the denim destination for teens, AEO is best positioned to capitalize on the ongoing resurgence in the denim cycle," said D.A. Davidson senior research analyst John Morris in a note to clients. 
• American Eagle's intimates brand, Aerie, is also becoming the dominant brand in its category for young adults, taking market share from embattled Victoria's Secret. 

The American Eagle Outfitters Inc. logo is seen on a pair of pants at a store in San Francisco, California, U.S., on Wednesday, March 6, 2013. American Eagle reported adjusted fiscal year 2012 earnings for the 53 weeks ended February 2, 2013 of $1.39 per share, a 43% increase from fiscal year 2011 adjusted earnings. Photographer: David Paul Morris/Bloomberg via Getty Images

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Jeans are making a comeback, and American Eagle is best positioned as the go-to spot for denim, according to D.A. Davidson. 

The firm initiated the retailer's stock with a buy rating and a $21 price target. Shares last traded around $16.55 per share. 

"As the denim destination for teens, AEO is best positioned to capitalize on the ongoing resurgence in the denim cycle," said D.A. Davidson senior research analyst John Morris in a note to clients. 

Jeans are making a comeback, with companies like Levi Strauss entering the public market this year. American Eagle is the leader in the skinny jeans trend as the retailer has mastered the trend in style, fit and fabric, said Morris. The clothing company is well positioned compared to its competitors Forever 21, Aeropostale, Abercrombie & Fitch, and PacSun, as they lose market share due to their own "missteps," said Morris. 

Meanwhile, shares of American Eagle have pulled back, down more than 30% since May. Morris said the pullback in shares is a buying opportunity as young adults see the retailers as a place to buy jeans in an up-trending denim cycle. 

"Not a bad place to be for the Fall and Holiday seasons," said Morris. 

American Eagle's intimates brand, Aerie, is also becoming the dominant brand in its category for young adults, taking market share from embattled Victoria's Secret. 

Morris said the stock is trading at an attractive valuation, near historic lows on a forward price-to-earnings ratio basis. 

"The balance sheet is solid, with just over $330M in cash in 2018 and minimal debt," said Morris. "Overtime, we believe AEO can resume above-average top-line growth and has the potential to attain a low double-digit operating margin."

—with reporting from CNBC's Michael Bloom