Rising Commodity Costs Amid Weak Consumer Spending Could Dampen Aeropostale Margins

Aeropostale (NYSE:ARO) primarily competes with other specialty retailers like American Eagle (NYSE:AEO), Abercrombie & Fitch (NYSE:ANF), Gap (NYSE:GPS) and Urban Outfitters (NYSE:URBN). The company has seen steady growth in its profit margins over the past few years. EBITDA margins have increased from 10.4% in 2005 to around 19% in 2009 as Aeropostale has generated growth in comparable store sales, a metric used to measure retail sales strength.

We expect this trend to continue as the company explores ways to further optimize its supply chain, thereby improving operational efficiency. However, increasing raw material prices and a prolonged weakness in consumer spending could pose a headwind to our optimistic EBITDA margin outlook.

We anticipate Aeropostale’s EBITDA margin for in-store sales will increase in the years ahead, although at a slower pace than observed over the past few years, towards 22% by the end of our forecast period. However, Trefis members predict that this metric will decline towards 18% during the same period. A probable reason for the pessimistic outlook could be Aeropostale’s declining sales growth in fiscal 2010 over 2009. The member estimates imply a downside of 13% to our price estimate for ARO stock.

We currently have a price estimate of $54.78 for Aeropostale’s stock, well ahead of the current market price.

Growth in Comparable Store Sales and Merchandise Margins…

Aeropostale’s comparable store sales increased by 10% for fiscal 2009, but the growth rate has declined since then. For fiscal 2010, comparable store sales increased by only 1%. ^[1] Despite slower growth, the company has been able to generate significant sales through promotions and offers, leveraging its strong supply chain and operating model to sustain margins.

Aeropostale recorded $2.40 billion in net sales during fiscal 2010, an increase of 8% from the $2.23 billion generated in fiscal 2009. Aeropostale’s focus on controlling average unit cost (AUC) has enabled it to deliver healthy merchandise margins and record a full year increase of nearly 2.5% in fiscal 2009. As the company continues to achieve operational efficiencies, margins should improve further going forward.

… But Rising Raw Material Prices & Lesser Spending Could Impact Margins

Apparel and other accessories sales got a boost during the December 2010 holiday season, in part due to discounts offered by retailers to attract customers. However, sales growth reportedly slowed towards the end of the holiday season, raising concerns on the outlook for 2011. ^[2]

Adding to these concerns are trends of rising commodity costs. Cotton prices have more than doubled over the past year. Rising input costs could ultimately force retailers to pass on these costs to end consumers, which could hurt retailers’ sales numbers (see our article Downside to Aeropostale From Increasing Raw Material Prices).

See our full analysis and $54.78 price estimate for Aeropostale

Trefis Community Forecast

We estimate Aeropostale’s in-store EBITDA margin will increase from 19% in 2009 to nearly 22% by the end of our forecast period. By contrast, Trefis members project a decline in margins towards 18% during the same period. The member estimates imply a downside of roughly 13% to our $54.78 price estimate for Aeropostale’s stock.

1. Aeropostale Reports January Sales Results, Yahoo Finance, Feb 3, 2011 [↩]
2. Sales Up, But Stores Fret Over Outlook, Wall Street Journal, Jan 15, 2011 [↩]