Aeropostale’s Shortcomings And How It Can Address Them

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ARO: Aeropostale logo
ARO
Aeropostale

As we enter 2013, we think it worthwhile to revisit the key issues that Aeropostale (NYSE:ARO) is facing and what it means for the investors. Aeropostale’s business is confined to the U.S., where its basic apparel is losing out to its competitors’ fashion offerings. The brand acceptance has been weak, and the retailer’s over-dependence on limited vendors puts its supply chain at risk. Although Aeropostale has started taking some steps to increase the variety of its product offerings, it still has a long way to go.

While most apparel retailers in the U.S. were struggling during the recessionary environment, Aeropostale performed quite well. It was able to sustain its growth on the back of its low priced basic apparel lines. However, with the improvement in the U.S. economy, the retailer lost track of its growth and has not been able to recover since. The future prospects don’t look too good either.

See our complete analysis for Aeropostale

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Weak Brand Acceptance Has Been Troubling Aeropostale

Aeropostale sustained its growth in the recessionary environment by offering basic apparel at lower prices. In January 2009, the sales of apparel retailers such as Abercrombie & Fitch and American Eagle Outfitters (NYSE:AEO) slumped by 20% and 22%, respectively. During the same period, Aeropostale’s sales registered an 11% increase. [1] However, as the economy recovered, Abercrombie & Fitch and American Eagle Outfitters started lowering their prices. [2] With their better brands and fashion products at low prices, these retailers effectively nullified Aeropostale’s price advantage. [3]

As customers started shifting towards more popular brands and fashion wear, Aeropostale lost out on capturing this trend. Aeropostale’s strategies to adapt to prevailing fashion trends also proved unsuccessful. For instance, the introduction of new fashion wear in women knit tops and junior’s tops met with a negative customer response. According to customer feedback, Aeropostale was missing trendy silhouettes, bright colors and fashion newness. This led to a reduction in comparable store sales, which continued until the last quarter. [4]

What is the retailer doing to address this issue?

Although Aeropostale mainly offers basic casuals, it also includes a limited variety of fashion apparel. These apparel products have performed well, but their proportion in the overall merchandise range remains limited. During its recent Q3 results, Aeropostale stated that it is slowly increasing the variety of fashion apparel within its products. [5] However, the retailer intends to take it slow with effective planning to ensure the success of this strategy. Once this is attained, it will need to have strong control over its inventory in order to improve its response time of bringing new products to the market. Aeropostale also expects to improve its most important business segment, women’s apparel, with the acquisition of online retailer GoJane.com which specializes in apparel and footwear for women.

We believe that while the worst may be over for Aeropostale, the recovery is likely to remain slow in near term.

Aeropostale Lacks International Footprint

Unlike its competitors such as Abercrombie & Fitch (NYSE:ANF) and Gap (NYSE:GPS), Aeropostale’s operations are confined to North America. It operates only 14 licensee stores in South East Asia and the Middle East. [4] While the teen apparel market is highly promotional in the U.S., the retailers are at liberty to exploit the lack of competition in international markets. This, along with slightly better economic conditions in the Middle East and Asia, allows them to operate a greater number of full-priced stores. This leads to better margins for the retailers and is one of the reasons why Aeropostale’s operating margins are lower than that of its competitors. Moreover, Aeropostale lacks a presence in China and Japan, which have been lucrative markets for other apparel retailers such as Abercrombie & Fitch, Gap (in China) and Urban Outfitters (in Japan). [6]

While it is true that the international expansion will help, the retailer needs to do better in the U.S. first. Expanding internationally without getting a grip on the domestic business might not be welcomed by the investors, and could make the situation worse if the expansion is unsuccessful.

Supply Chain Is Susceptible To Risks

Like most retailers, Aeropostale outsources its manufacturing operations to countries where labor costs are cheaper. The retailer is highly dependent on a small number of vendors for its inventory. About 87% of its inventory comes from five vendors. [4] A change in strategy of any of these vendors or a delay in supply can adversely affect the retailer. In order to reduce the lead time, retailers such as Abercrombie & Fitch started sourcing their merchandise form within the U.S. and Central America. [7] Aeropostale should do something similar as higher lead times can prevent the retailers from launching new product lines, at the start of the season. This can have a negative impact on their comparable stores sales, which is a key metric driving apparel stocks.

Our price estimate for Aeropostale stands at $13, which is roughly in line with the market price.

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Notes:
  1. Retail Sales Fall In January, la times, feb 6 2009 []
  2. Aeropostale: Between a Rock and a Hard Place, Seekingalpha, July 10 2011 []
  3. Aeropostale: Between a Rock and a Hard Place, Seekingalpha, July 10 2011 []
  4. Aeropostale’s SEC filings [] [] []
  5. Aeropostale’s Q3 fiscal 2012 earnings transcript, Nov 28 2012 []
  6. Companies’ SEC filings []
  7. Abercrombie & Fitch’s Q2 fiscal 2013 earnings transcript, Aug 15 2012 []