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By Brian Sozzi

Aeropostale (NYSE:ARO) options spiked in the middle of last week on rumors that it's in play as a takeover. It appears that retail buyout rumors have shifted from the overplayed hand that was a pair trade of Abercrombie & Fitch (NYSE:ANF) and American Eagle (NYSE:AEO). While I am not saying Aeropostale doesn't have the characteristics that PE shops are seeking, especially after a selloff in the stock post 3Q earnings and a related 4Q earnings warning, I don't believe now is the time to put the ARO takeover trade on.

The stores are currently advertising a 70% off the entire store promotion, up from 50% in the month of November. Will management's 3Q earnings warning stick? Or, is there another waiting in the wings? If pushed, I fancy another earnings warning is around the corner, which will serve to depress the stock price even further.

A little history on Aeropostale for a moment. The Aeropostale trade was all the rage in 2009. Logic underlying the trade was simple; with consumers being mindful of discretionary purchases, those retailers offering great prices flourished. Aeropostale's comparable store sales (comps) ranged from +9% in 4Q09 to +12% in 2Q09, outperforming others in the teen specialty apparel sector. The increased level of store productivity and tame input cost inflation propelled gross margin to previously unseen rates. Unfortunately, the good times have stopped for Aeropostale for the time being, with the negatives becoming more pronounced in 2H10.

Comparable store sales (comps) have slowed on a sequential basis for five consecutive quarters amid a trade back up by consumers and intensified competition on price by Abercrombie & Fitch's namesake, Hollister, and American Eagle Outfitters. At the very root of the apparent market share loss in my view are an absence of fashion items at Aeropostale, and an overload of basics such as graphic t-shirts and fleece. Price competition on basic items is not a winning strategy for a specialty retailer when the consumer is voting that they yearn for style. I believe Aeropostale management acknowledged the missing fashion quotient in the assortment and divergence from historical color palettes by promoting Thomas Johnson as the sole CEO, pushing aside Mindy Meads, who had the responsibility for merchandising and developing the design team.

Fundamentals at Aeropostale are likely to remain unimpressive at least until 2H11 as merchandise is bought for spring and summer. Moreover, there is no saying that opportunities will be executed upon for back to school and holidays 2011.
I think Aeropostale, despite a month plus of aggressive promotions (more so than usual), is poised to mark down guidance further as the fourth quarter comes to a conclusion as consumers search for value that is not solely centered on price. Strong traffic and conversion trends at Hollister and Abercrombie & Fitch, in addition to momentum in denim at American Eagle to go along with better fashion in tops, suggest Aeropostale is the share loser currently.

For FY11, I have set my EPS estimate at $2.52, down from a previous estimate of $2.89, as a misaligned assortment, product input inflation, competitive pricing forces, and costs of new store openings places risk to current consensus forecasts. The stock presently trades on a P/E multiple of 9.3x my FY11 estimate, an approximate 50% discount to my teen specialty apparel sector coverage average. Value seekers beware, however. I believe it will be difficult for Aeropostale shares to fetch a higher P/E multiple given tough two-year gross margin/comp comparisons and the clear challenges that the business is facing.

Disclosure: No position

Source: Is Aeropostale Dead Money Near-Term?