Time to Nibble at Aeropostale

| About: Aeropostale, Inc. (ARO)
Company Overview: Aeropostale, Inc. operates as a mall-based specialty retailer of casual apparel and accessories. It designs, markets, and sells merchandise principally targeting 14 to 17 year-old young women and men. The company offers a collection of apparel, including graphic t-shirts, tops, bottoms, sweaters, jeans, and outerwear, as well as accessories, including sunglasses, belts, socks, and hats. It also offers casual clothing and accessories focusing on elementary school children between the ages of 7 and 12. In addition, the company sells its products through its e-commerce Website, aeropostale.com. As of March 15, 2010, it operated 895 Aeropostale stores in 49 states and Puerto Rico; 44 Aeropostale stores in Canada; and 15 P.S. from Aeropostale stores in 6 states.
Prognosis: The stock has dropped nearly 20% since spring on concerns about possible markdowns during the back to school season, a downgrade, and continued poor job numbers especially among their core teen customer. However, we believe those concerns are more than reflected in its stock price.
Valuation: ARO is selling for approximately 9 times this year’s consensus earnings and 8 times next year’s projected earnings. The company has almost doubled its operating cash flow in the last two fiscal years despite a very difficult retail environment. ARO also has over $3/share in net cash on its balance sheet.
Catalysts: There are several factors that we believe should provide support for a higher stock price in the near and medium term:
1. ARO’s tween concept store P.S. still has plenty of room to grow even as its core franchise reaches its saturation point in the States over the next five years
2. Company does marvelous job of leveraging it assets, its ROA is more than four times its primary competitors Abercrombie & Fitch and American Eagle
3. Its value based brand marketing should position itself well given the economic environment we foresee over next couple of years
4. Company is just starting to expand internationally, which could be an important channel of growth in the coming years
5. Store’s new format is increasing same store sales, and company should benefit as the concept is rolled out to all of its stores
Recommendation(s): Given its solid revenue streams, low valuation and strong cash flow; we feel Aeropostale stock is currently undervalued. In our opinion, the stock should be trading at a more reasonable rate of approximately 11-12 (the low end of its historical valuation prior to economic crisis) times this year’s projected earnings of around $2.75. Our target price is $30-$33, up from the current price of $23.10. Our strategy is to buy half our normal position now and pick up the other half if the ARO earnings report this week disappoints.

Disclosure: Long ARO