What's The Outlook For Aeropostale's Branded Stores?

| About: Aeropostale, Inc. (ARO)

Aeropostale (NYSE:ARO) operates Aeropostale and P.S. from Aeropostale stores in North America, as well as direct-to-consumer business globally. Although the direct-to-consumer business is growing quickly, Aeropostale's physical stores still account for over 90% of its revenues. In 2011, Aeropostale's U.S. stores generated $2.16 billion in revenues and $315 million in EBITDA. Though the company has struggled in the past couple of years, it has recently started taking some steps to revive its growth. In this analysis, we will discuss how the retailer makes money through these stores and what strategies it is adopting to improve its sales.

How Do Aeropostale Stores Make Money?

All of Aeropostale's stores are in the U.S. and Canada. As of Q3 fiscal 2012, the retailer operated around 992 Aeropostale stores in these two countries. Through these stores, the retailer offers its own brand of high quality merchandise for men and women in the age group of 14-17 years at affordable prices. The retailer focuses on an exciting store environment to enhance the shopping experience. Additionally, through its 99 P.S. from Aeropostale stores, the company offers casual clothing and accessories for elementary school children in the age group of 4-12 years.

Expansion in the U.S.

While competitors such as Gap (NYSE:GPS) and Abercrombie & Fitch (NYSE:ANF) are consolidating their stores in the U.S. to increase store productivity, Aeropostale is expanding its network. Being a mall-based retailer, Aeropostale's stores are smaller in size compared to Gap's stores, and generate significantly higher revenue per square feet. Moreover, before cotton prices climbed in 2011, Aeropostale's stores generated about $150 in EBITDA per square feet compared to Gap's $90. Although higher cotton prices troubled both the retailers, the impact was larger on Aeropostale. The EBITDA per square feet for both the brands dropped to around $80 in 2011. As a value-focused retailer, Aeropostale didn't have much room to raise prices without risking sales and therefore it had to absorb a large chunk of costs.

Over the long term, Aeropostale needs to elevate its brand image in the U.S. to better manage cost pressure and operate with fewer promotions. We believe it makes sense for the retailer to expand its reach in the U.S. and cater to a larger customer base. Aeropostale increased its store count from 914 in 2008 to 1,057 in 2011, which led to an average annual revenue growth of 9%.

Going forward, we expect the store count to increase driven by the growth of P.S. from Aeropostale brand. Aeropostale operated only 71 P.S. from Aeropostale stores in the U.S. as of 2011, but plans to expand them aggressively. For fiscal 2012, Aeropostale planned more stores for P.S. for Aeropostale (30) compared to its namesake brand (18). The pace of expansion is evident from the fact that the retailer had opened 28 of these 30 stores stores by the end of Q3 fiscal 2012.

How Is Aeropostale Looking to Improve Its Store Sales?

Improving Shopping Experience: Aeropostale emphasizes on providing an enjoyable in-store experience to attract customers. Last year, the retailer installed iPods, iPads, and Apple (NASDAQ:AAPL) desktops throughout its store to improve the shopping experience. The customers can use the build-your-own-outfit guide on the iPads installed in the store to optimize and design apparel according to their own preference. Furthermore, they can select different music in the changing room and vote for the music playing in the stores. This is something that many youngsters will find interesting and enjoyable. The retailer also provides an in-store e-commerce platform to make shopping convenient. The target customers (teenagers) are likely to be more tech- friendly than other age groups and will welcome this technological addition.

Increasing Penetration of Fashion-Based Apparel: Aeropostale offers a limited variety of fashion-based apparel. However, the retailer recently reported good customer response to its fashion-based apparel such as tops, wovens, colored and printed denims. This is contrary to what happened in 2011, when the customer response was quite weak toward knit tops and juniors' tops. Backed by a positive response, the retailer is planning to increase the proportion of fashion-based apparel in its merchandise range.

Even though Aeropostale's comparable store sales growth has been under pressure due to heavy discounts and shift in sales mix toward low cost apparel, these strategies enabled a minor rebound of 2% in its store traffic in Q3 fiscal 2012. Prior to this quarter, the retailer saw a negative change in its store traffic for six consecutive quarters.

Our price estimate for Aeropostale stands at $13, implying a premium of about 5% to the market price.

Disclosure: No positions.

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