Aeropostale Earnings Preview: Gross Margins in Focus

Aug.17.11 | About: Aeropostale, Inc. (ARO)

With Aeropostale’s (NYSE:ARO) stock sliding to half its value over the last quarter, investors are eager to hear from Aeropostale’s management in the upcoming earnings release on August 18th. The stock plummeted by more than 20% to reach $13 after the company released the dismal Q2 sales data on August 4th with a fall of 5% in its net sales and a significant double digit decrease in same store sales. In the last 5 days, Aeropostale has underperformed its leading competitors like Abercombie & Fitch (NYSE:ANF), American Eagle Outfitters (NYSE:AEO) and Gap (NYSE:GAP).

We value Aeropostale with a $26 price estimate, which is roughly 120% above market price. This view is predicated on the assumption of long-term margin recovery that we forecast for Aeropostale and the view that sales will not drop precipitously in the coming quarters as the market seems to suggest.

Gross margins remain in focus

With the stock already taking a beating due to a decline in net sales, the company’s gross margins have become the center of our attention in this quarter’s earning release. The company suffered a massive decline of over 10% in gross margins last quarter due to higher production costs on account of rising cotton prices. With the cotton prices beginning to decline, we expect the margins to ameliorate a little compared to last quarter.

However the effect will likely be offset by the subsequent rise in promotion costs due to fierce competition in teen apparel industry. One of the major highlights of the August 4 sales release was that the company was forced to spend more on promotions resulting in higher costs and therefore lower margins.

(Chart created by using Trefis' app)

We are very interested to hear not just the change in gross margins over the last year but also the change in margins over the last quarter as well. Gross margins and its ability to drive sales without heavy promotions and discounts will be very important as we head into the back to school season which will be hugely important for Aeropostale.

Disclosure: No positions