Cotton Price Trends Look Good on Aeropostale

Aeropostale (NYSE:ARO) designs and markets casual apparel and accessories for young adults and teens. The company competes with a variety of other retailers like American Eagle (NYSE:AEO), Abercrombie & Fitch (NYSE:ANF), Gap (NYSE:GPS) and Urban Outfitters (NYSE:URBN).

We have a $51.90 price estimate for Aeropostale’s stock, implying a hefty premium to the stock’s market price. We estimate that Aeropostale stores constitute around 79% of the stock’s value, with internet & catalog orders adding another 16%.

Cotton Price Down, Aeropostale Stock Up

Aeropostale may benefit from a drop in cotton prices. Cotton futures prices have been under pressure and experts believe that cotton prices could fall further by around 51%, to $1/pound, by the end of the year. The declining price is largely attributable to improving supply. ^[1]

This trend is welcome news for apparel retailers, especially Aeropostale, which is less of an up-market brand and is more reliant on volume than prices to drive sales. Since Aeropostale also resorts to a considerable amount of discounting, its margin are more vulnerable to commodity costs than up-market brands like Abercrombie & Fitch and American Eagle that enjoy price points 30-50% higher than Aeropostale.

Aeropostale was already planning to increase prices this year to offset increasing raw material costs. Playing the price game is probably something that Aeropostale should avoid, given that it lost market share last year after up-market competitors Abercrombie & Fitch and American Eagle lowered prices in the aftermath of the financial crisis. ^[2]

Aeropostale Store EBITDA Outlook

The EBITDA margin for Aeropostale stores increased from around 10% in 2005 to 19% in 2009, before dropping off slightly to about 18% in 2010. The decline in 2010 was driven by pricing pressure and increasing commodity costs. Going forward, we anticipate a modest, but steady recovery in EBITDA margins back towards the 19% level by the end of our forecast period.

However, if cotton prices continue to fall, there could be upside to our forecasts. To illustrate the potential impact of this scenario, we estimate that an increase in Aeropostale store EBITDA margin towards 20% by the end of our forecast period would imply a 5% upside to our $51.90 price estimate for Aeropostale’s stock. You can test this scenario, and others, by dragging the trend line in the interactive chart above.

See our full analysis for Aeropostale

1. Cotton Drops, ‘Dim Sum’ Bonds Pop: Market Bits [↩]
2. Higher cotton cost weighs on Aeropostale forecast [↩]