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Investment Overview for Aeropostale (NYSE:ARO)
- Aeropostale Revenue per Square Foot: Aeropostale was one of the strongest performers during the recessionary environment as it offered basic products at relatively low prices. However, the retailer's revenue per square feet has been coming down since 2010 as customers are moving towards other trendy brands. Due to the lack of fashion focused products, Aeropostale's revenue per square foot declined to $568 in 2011 and $548 in 2012. Although, the company tried to boost its fashion offerings in 2013, the customer responsed negatively. Therefore, We expect this figure to decline in the near team and slightly improve thereafter as P.S. from Aeropostale grows and the company moves to lucrative international locations, where low prices still remains the key selling point. We expect the figure to reach $533 by the end of the Trefis forecast period.
However, if the company still continues to rely heavily on its basic offerings and its fashion products fail to attract customers, its revenue per square foot will continue to decline. If the figure reaches $480 by the end of the Trefis forecast period, there can be downside of 10% to our Trefis price estimate. Conversely, if Aeropostale manages to get its products inline with customer preferences and keeps their prices under control, its revenue per square feet can improve. If the figure reaches $590 by the end of Trefis forecast period, there can be upside of 10% to our price estimate.
- Aeropostale Stores EBITDA Margin: Aeropostale Stores EBITDA Margin declined massively in 2011 due to an increase in cotton costs and higher markdowns. In 2012, better cotton prices did not help the retailer as it offered heavy discounts to attract store traffic. The margins are likely to decline in the near term due to highly promotional retail environment. However,they can stabilize in the long-term as the company reduces its operating expenses with the consolidation of under-performing stores.We forecast the figure to reach 12.2% by the end of Trefis forecast period.
However, if the apparel market continues to be exceptionally promotional and Aeropostale's products fail to attract customers, it can result in higher markdowns. If the margin's plummet further to 11% by the end of Trefis forecast period, there can be downside of 10% to our price estimate. Conversely, if the promotional environment ceases to continue, the company expands successfully in international markets, and gets its fashion category inline with the customer preference, it can operate with fewer discounts. It this pushes the margins to 14%, there can be upside of 10% to our Trefis price estimate.
Aeropostale is a mall based specialty retailer of casual apparel and accessories. It designs, markets and sells its own brand of merchandise through its retail stores and the internet. Aeropostale provides customers with a focused selection of high quality, active oriented fashion at competitive prices. The average Aeropostale store is generally smaller than that of many of its mall-based competitors.
With its major brand Aeropostale, the company offers merchandise to young men and women belonging to 14-17 age group. Its other brand P.S. from Aeropostale offers casual clothing and accessories focusing on elementary school kids between the ages of 7 and 12.
Aeropostale's Internet & Catalog business is relatively young and does not contribute much to its revenues presently. However, this business has been growing rapidly following the online retail industry trend.
Aeropostale's Revenue per Square Foot and Number of Stores
Between 2007 and 2010, the revenue per square foot for Aeropostale stores increased from $545 to $626 and the number of stores from 828 to 1,012. The impact of the driver can be gauged by the fact that Aeropostale lost nearly 40% of its stock value in 2011 as revenue per square foot declined due to an imbalance in the company's product mix.
In comparison, revenues from internet and catalog sales increased from around $42 million in 2005 to about $217 million in 2012.
Edgy retail environment
At present, the U.S. teen apparel market is very weak due to low consumer spending and high unemployment rate. Teenagers are either depend on their parents for money or they earn themselves. Both the scenario's do not look good at the moment. The 2% payroll tax increase earlier this year has left an average U.S. consumer with less to spend. Moreover, the unemployment rate in the teenage segment is high 23.7% (July 2013).As a result,a number of retailers such as American Eagle Outfitters and Abercrombie & Fitch have struggled with their growth. The near term does not look good for the retail industry as the aforementioned aspects will continue to impact the U.S. buyers. However, some players such as Urban Outfitters and Gap have done well as they are fast fashion and value-for money brands, and have established a strong brand identity in the market.
Low proportion of fashion focused products
Although Aeropostale primarily offers basic products, it does have a limited proportion of fashion focused products as well. The main reason behind the retailer's struggle was the fact that the shoppers were not attracted towards the brand as they did not find prevailing trends in its products. As a result, the company had to offer high discounts in order to attract store traffic. Although Aeropostale tried a complete product overhaul as it added trendy products such as studded combat boots, lacy ruffled tunics etc., the customer response wasn't good. The changes were drastic and the prices were too high compared to what the company usually offers. This will continue to weigh on Aeropostale's revenue per square foot unless it adds some relevant fashion to its products.
Aeropostale's 3 long-term growth strategies
In its 2012 spring conference, Aeropostale's president Michael J. Cunningham, announced the three long term growth strategies of Aeropostale, which is international expansion, increasing scale of the direct business and growth in P.S. from Aeropostale.
Aeropostale has signed agreements with licensing partners to open stores in Columbia and Panama. Additionally, it recently entered the Mexican market and plans to add 30 stores in Turkey within the next five years. These markets provide good potential for value focused brands, which bodes well for Aeropostale. However, the company is missing out on a valuable expansion opportunity in the growing Chinese market.
The retailer is emphasizing on its direct-to-consumer business by focusing on e-commerce, m-commerce and f-commerce channels. Moreover, it plans to aggressively expand its P.S. from Aeropostale stores throughout the entire U.S. market. This brand has found good acceptance among the target customer segment and will help the company in the long term. For fiscal 2012, Aeropostale plans more stores for P.S. for Aeropostale (60) than its namesake brand (14).
Store consolidation in the U.S.
Like other players such as Gap, and American Eagle Outfitters, Aeropostale in also looking to close some of its under-performing stores to reduce its expenses and improve the revenue per square feet. For this year, Aeropostale planned about 15-20 store closures, but increased it to 30-40 stores after the end of the second quarter. We expect the retailer to follow this strategy for a few years, which will help it offset the decline in revenue per square feet and EBITDA margins.
Trefis Forecast Rationale for Aeropostale Stores EBITDA Margin
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) are profits after factoring in typical expenses such as Cost of Goods and Services Sold, SG&A Expense and R&D Expense. EBITDA Margin represents divisional EBITDA as a percentage of divisional revenues. We adjust EBITDA figures to exclude non-recurring charges and non-cash charges such as Stock-Based Compensation Expense.
EBITDA margin's for Aeropostale stores increased from around 22.72% in 2008 to 26.07%in 2009. The improvement in merchandise margin was primarily due to improved merchandise sell-through and lower markdowns. The figure fell slightly in 2010. Aeropostale registered a steep decline in margins in 2011 due to an increase in production costs, primarily due to an increase in cotton prices. An increase in promotions to drive sales took a toll on margin's in 2012.
Going ahead we expect the margins to continue to decline in the near term due to heavy promotions and weak response to fashion products. Thereafter, we expect them to stabilize at 12.2% due to lower operating expenses as a result of store consolidation and growth of P.S. from Aeropostale.
Trefis considered the following factors for its forecast:
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- Heavy markdowns likely to continue
- Aeropostale has been struggling to hold onto its customers as it only offers basic products such as graphic tees and jeans, which usually do no reflect latest fashion
- Therefore, the company relies on heavy discounts to compensate for the low store traffic, which brings the margins down.
- Since most of Aeropostale's products belong to the basic category, it will continue to offer heavy discounts which will weigh on its margins.
- Product overhaul might not help
- Aeropostale tried a complete product overhaul by adding preppy and edgy products, such as studded combat boots to its portfolio
- It even tried to re-position its brand image to "trendy" with a big marketing campaign -"Aero Rocks" fashion party.
- Although the move was right, the changes were drastic and the product prices were too high. As a result, the customer response turned out to be poor and the company had to again usher large markdowns.
- Since even more fashion did not work for Aeropostale, its margins are likely to decline going forward.
- Higher SG&A Expenses
- Over the past three years, SG&A expenses as a percentage of revenues have been increasing due to expenses related to marketing and e-commerce growth
- As Aeropostale is focused on improving its brand image in the U.S., it will continue to invest heavily in marketing.
- This will create negative margin pressures.
- Consolidation of under-performing stores will help the margins.
- Since revenue growth is becoming a tough ask for Aeropostale, it is looking to improve its store productivity
- The retailer is planning to consolidate its under-performing store network in order to improve its margins.
- At the start of fiscal 2013, it planned 15-20 store closures during the year, but increased the figure to 30-40 after the second quarter.
- We expect the company to continue this strategy for a few years, since it has a number of stores that are not delivering the desired results.
- A drastic change in cotton prices is less likely
- From $0.84 per pound in July 2010, cotton prices rose to $2.30 per pound in March 2011. The major factor behind this price increase was the drought in Hubei province of China, a major cotton producing area. Government restrictions on exporting cotton out of India and a devastating flood in Pakistan further contributed to the supply shortage.
- As cotton is one of the key raw materials for apparel retailers, a sudden spike in cotton prices resulted in an increase in manufacturing costs. However, cotton prices declined to $0.83 per pound by the end of 2012 as China recovered from the drought and India eased its regulation on cotton export.
- Cotton prices have declined thereafter, reaching $1.01 per pound by the end of January 2012.
- With China steadily building up its cotton reserves, we do not expect cotton prices to go up. Currently the country holds a record cotton inventory of 10 million tons, which has brought the U.S. cotton prices per pound down from 88 cents in 2012 to 71 cents in 2013.
- With ample cotton reserves and lower prices, retailers such as Aeropostale should be able to reduce their manufacturing costs and sustain margins.
- International expansion to benefit margins
- International expansion in markets which have relatively better macro-economic conditions is a long term strategy of Aeropostale.
- Aeropostale can realize a higher full-priced merchandise sale in international markets contrary to in the U.S. Additionally, the company can also pass cost pressures to customers more easily internationally, thus negating the margin pressures in the domestic market.
- As the contribution of international revenues to the company's net sales increases, We expect margin's to improve.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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