Aeropostale: A Retailer with Plenty of Upside Potential

 |  Includes: AEO, ANF, ARO
by: Southhill Partners
Aeropostale (NYSE:ARO) is a specialty retailer for junior high and high school students aged 11-17. The chain store aims to provide great fashion at compelling value, which it has been very successful at over the past several years.
Both revenue and earnings grew year over year very nicely. With strong cash flow and zero long-term debt, Aeropostale continues to invest in new stores and the expansion of existing stores, and is planning for 7% footage growth next year. Together with same store sales growth, revenue should continue to grow nicely in 2010. The company's operating margins had improved over the past several years to 16% this year. Further analysis shows Aeropostale is a very efficient, well managed business, generating impressive ROE year over year. (Click to enlarge)
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Technologies play an important role in Aeropostale’s operation. Through its inventory management system, Aeropostale is able to turn its inventories nearly 10x annually, much higher than the industry average of 7.7x. Aeropostale also runs the most productive stores in the industry, grossing annual revenue of over $600 per square foot. The management believes technology driven efficiency to be one of its major competitive edges, and has committed to more infrastructure improvement to further expand operating margin.
In early December, Aeropostale reported Q3 results with record breaking revenue and operating margin. However, its stock price fell 30% from all time high of $45 to below $30, apparently due to the 7% November Same Store Sales increase, which missed the expectation of 8.5%. 7% is actually a very good number, considering the fact that many retailers posted negative comps for the same month.
Competition is increasing, particularly from Abercrombie and Fitch (NYSE:ANF), American Eagle Outfitters (NYSE:AEO) and Old Navy. But Aeropostale appears to have the capability to sell its products at prices more competitive than its competitors, while still maintaining good operating margin and profitability. This, I believe, is largely due to Aeropostale’s highly efficient infrastructure and highly productive stores.
Cramer made a bearish call on Aeropostale back on Dec. 4th, comparing it to a Meteoroid. But Cramer is wrong for the following reasons: (1) Aeropostale’s historical success could not simply be attributed to a specific type of fashion, but also the business’s capabilities to adjust to the latest trends and to improve its efficiency and productivity. (2) Aeropostale’s promotional strategy should work well in this weak economic environment. The concern that Aeropostale comps may go negative is overdone. Historically, competitors who attempted to mimic its strategy had not being able to perform as well. (3) With ample cash on hand, Aeropostale’s management has once again expressed their confidence in the company by ratcheting up its stock repurchase plan in early December.
While I’m working on this article, Aeropostale’s stock price has bounced back quite a bit from its recent low of $28 in early December. However, trading at $34, or 10.5x 2009 EPS, I believe Aeropostale is still attractive. As doubts on Aeropostale gradually fade, its stock should be able to trade at around 13x forward looking EPS, representing about 30% upside potential.
Disclosure: No position in all mentioned