Downside to Aeropostale From Increasing Raw Material Prices

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Trefis
ARO: Aeropostale logo
ARO
Aeropostale

Aeropostale (NYSE:ARO) is a specialty retailer that sells casual apparel and accessories targeted to youths.  Aeropostale’s primary competitors include American Eagle (NYSE:AEO), Abercrombie & Fitch (NYSE:ANF), Gap (NYSE:GPS) and Urban Outfitters (NYSE:URBN).

Aeropostale designs, markets and sells its own brand of merchandise through its retail stores as well as through the Internet and catalogs sales channel, which accounts for 16% of our price estimate. We estimate that the Aeropostale stores constitute around 78% of our $54.78 price estimate for Aeropostale’s stock, which stands well ahead of current market price.

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Holiday Spending Firm, but Outlook Uncertain

Clothing and clothing accessories business increased 7.4% YOY in December 2010, according to the U.S. Department of Commerce. Positive result to end 2010, but outlook remains choppy going into 2011, with sales slowing down towards the end of the holiday season. The rapid growth in sales during the early part of the season has in part been attributed to the hastiness of retailers in offering discounts to attract shoppers. High unemployment levels and slow growth in wages are some factors which are expected to continue into 2011 and can impact sales of retailers. [1]

To add to the limited spending power of consumers, higher commodity prices are adding further concerns to retailers going into 2011. With cotton prices having more than doubled over the past year, apparel retailers will need to increase prices for the spring merchandise. This could hurt the sales of Aeropostale, which markets itself has providing trendy apparels at a discount to more up market brands like American Eagle and Abercrombie & Fitch. On average, the price points for Aeropostale are around 30% lower than American Eagle and 50% lower than Abercrombie & Fitch. Aeropostale expects to increase prices by 3-5% in the spring. However, it is looking to maintain lean inventories in order to reduce merchandise markdowns, thereby sustaining margins.

The EBITDA margin for Aeropostale Stores increased from around 10% in 2005 to 19% in 2009. Going forward, we expect it to increase gradually to around 22%, as the company believes that there is further scope for optimizing its supply chain and improving operational efficiency. However, we discussed in an earlier article the possible downside to its sales as the economy recovers and to its margins due to its promotional marketing strategy. (See: Aeropostale’s Sales Could Slump as Economy Recovers)

However, weak consumer sentiment and rising raw material prices going into 2011 indicate that there can be a downside to our forecast. If the Aeropostale Stores EBITDA Margin falls to around 16% by the end of our forecast period, it would mean around 18% downside to our current price estimate for Aeropostale’s stock.

See our full estimates for Aeropostale here.

Notes:
  1. Sales Up, But Stores Fret Over Outlook []