Aeropostale: Profitable and Growing, Part 2

Sep.12.10 | About: Aeropostale, Inc. (ARO)

Aeropostale (NYSE:ARO)
Gross Margin Trends:

Year Gross Margin
2002 30.5%
2003 32.3%
2004 34.2%
2005 31.6%
2006 33.9%
2007 36.6%
2008 37.2%
2009 39.9%
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The annual gross margin trends (table above) are not only consistent but have gotten better over the years.

Quarter Gross Margin
2007 Q1 35.1%
2007 Q2 33.7%
2007 Q3 37.1%
2007 Q4 38.4%
2008 Q1 36.0%
2008 Q2 36.1%
2008 Q3 38.2%
2008 Q4 37.8%
2009 Q1 39.1%
2009 Q2 39.4%
2009 Q3 41.5%
2009 Q4 39.3%
2010 Q1 42.3%
2010 Q2 37.3%
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I do not see any cause for concern in the quarterly gross margins either.

Sales-per-square-foot data

Here is the information from the company website.

Year Sales per sq feet Store Count Same store sales increase
2005 $534 671 4%
2006 $543 742 2%
2007 $545 828 3%
2008 $572 914 8%
2009 $624 952 10%
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As can be seen in the table above, sales per square foot have increased each year, along with increase in store count. SSS have done pretty well year over year. The strength in 2008-2009 in SSS (up 8% and 10%), when the rest of the retailers were struggling, is simply superb.

Examine Inventory/Receivable trends

These are changes to sales and inventory over prior quarter.
Quarter Sales Inventory
2007 Q1 -45.6% 6%
2007 Q2 12.8% 40%
2007 Q3 32.6% 27.7%
2007 Q4 43.3% -29%
2008 Q1 -43.1% -1.1%
2008 Q2 12.1% 36.1%
2008 Q3 27.8% 12.6%
2008 Q4 43.2% -38.9%
2009 Q1 -40.9% 2%
2009 Q2 11% 55.9%
2009 Q3 25.3% 10.2%
2009 Q4 41.1% -40%
2010 Q1 -42.1% -7.7%
2010 Q2 6.7% 75.6%
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ARO does not have receivables to speak of. So, that is excluded.

Sequential change to Sales v/s Inventory on a quarterly basis is quite interesting for a retailer. Q4 is the big sales season for retailers. Typically, there is a buildup in inventory in the first 3 quarters of the year, especially in Q2. The huge sales period in Q4 drives down inventory. So, if you look at 2009 Q4, you will see that sales shot up 41% over Q3 and inventory dropped by 40%. Q1 is always going to see a drop in sales when compared to Q4 of the prior year.

The only negative is that there was a larger than normal increase in inventory in 2010 Q2 (up 75.6%). I went back to past years and saw an increase of 81.6% in 2005 and 89.7% in 2003. So, it has happened in the past. I would expect Q3 to have a much smaller increase in inventory.

Let’s also look at year over year comparisons of sales and inventory

Year Sales Inventory
2002 80.7% -20.6%
2003 33.4% 32.6%
2004 31.2% 31.4%
2005 24.9% 13.2%
2006 17.3% 10.4%
2007 12.6% 34.5%
2008 18.5% -7.4%
2009 18.3% 5.1%
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With the exception of 2007, Sales have grown much more than inventory on a year over year basis. Once again, 2008 and 2009 stand out for the sales growth of 18%.

6. Examine same-store-sales (SSS) data closely

Apparently this is the most important metric in retail sales analysis. Same-store-sales data reveals how a store, or a number of stores, fares on a period-to-period basis. Ideally, an investor would like to see both sequential and year-over-year same-store-sales growth. Such an increase would indicate that the company's concept is working and its merchandise is fresh.

Quarter SSS
2007 Q1 3%
2007 Q2 -4.1%
2007 Q3 1.9%
2007 Q4 +9.2%
2008 Q1 +10%
2008 Q2 +11%
2008 Q3 +7%
2008 Q4 +6%
2009 Q1 +11%
2009 Q2 +12%
2009 Q3 +10%
2009 Q4 +9%
2010 Q1 +8%
2010 Q2 +4%
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Amazingly, ARO has had only one quarter of decline in SSS on a quarter over quarter basis back in 2007 Q2. While the recent quarter shows a slowdown in the SSS growth, you have to keep in mind that this comes on the back of two monstrous years of SSS growth.

Comparing P/E ratio to expected earnings growth rate.

Yahoo Finance shows a PEG ratio of 0.63. Anything less than 1 for the PEG ratio is considered attractive. This means ARO earnings are poised to grow much faster than the multiple Mr Market has currently put on its earnings.

Year EPS growth Sales growth Net Income Diluted Shares
2002 166.7% 80.7% 177% +6.8%
2003 70.8% 33.4% 73.5% +2.6%
2004 58.5% 31.2% 54.9% -1.8%
2005 3.1% 24.9% -0.1% -2.3%
2006 31.3% 17.6% 26.9% -5.7%
2007 30.7% 12.6% 21.2% -5.4%
2008 27.8% 18.5% 15.6% -9.7%
2009 54.4% 18.3% 53.6% -0.4%
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The above table shows a highly consistent growth in sales, net income and EPS. You will notice the EPS grows even faster than net income due to the consistent share buyback program as shown in the last column. While I do not expect growth in Sales and EPS to continue at the rates seen from 2002-2009, I would expect a 5-10% increase in sales and a 10-15% increase in EPS. The sales growth should be driven by increase in store count, SSS and sales per square feet as well as the increase in online sales. EPS growth should be higher than sales growth due to the continued share buy-back program and the operating leverage of the business.

Tangible book value

ARO has total equity of $497.5 million. At its current market cap of $2050 million, I arrive at a book value multiple of 4.12. There are no intangibles on the balance sheet. The only negative here is that competitors such as American Eagle Outfitters (NYSE:AEO) and Abercrombie & Fitch (NYSE:ANF) have a 1.5x multiple of book value compared to 4x of ARO.

Conclusion: I have seen nothing in the above analysis to cause me any concern. On the contrary, all the data shows me a company and management that is functioning well, growing consistently and profitably over several years. I reiterate my buy rating on ARO.

Disclaimer: I have a long position in shares of Aeropostale at the time of publishing this report. My position may change at any time without any further updates. Please conduct your own research before considering an investment. This report is presented as a way to share my research and not as formal recommendation of investment or advice.

Disclosure: Long ARO