Aeropostale (NYSE:ARO) reported negative growth during Q2 fiscal 2013 and slashed its guidance for the third quarter. The retailer’s comparable store sales fell by 15% and its gross margins shrunk by 7.4% on the account of highly promotional retail environment and weak teen spending. Aeropostale’s business has remained weak in general due to low store traffic and lack of fashion apparel. Although the company tried to add more fashion offerings to its assortments this time, customer response was lukewarm leading to large promotions to clear the inventory.
Aeropostale does not expect the third quarter to be any different as the current store traffic trends and promotional environment will likely continue throughout the back-to-school season. The retailer is now focusing on decreasing operating expenses and improving store productivity as it plans to consolidate its underperforming store network. In an otherwise dismal quarter, Aeropostale’s e-commerce business registered 22% revenue growth providing a ray of hope. However, the revenue contribution of this channel is still small and the retailer needs to get its fundamentals right if it has to turn around its business.
Weak Teen Spending Undermined Fashion Changes
The problems that Aeropostale has faced in the past are mainly attributable to its over dependence on core basic categories such as graphics and fleece, and a limited assortment of fashion-focused apparel. In Q2 fiscal 2013, the retailer tried a complete overhaul with a head-to-toe approach as it deepened its fashion offerings and added new product categories such as footwear.  The company started offering trendy products such as lacy ruffled tunics, studded combat boots, floral anorak jackets etc.  It also launched some marketing campaigns to reposition the brand as fashionable, and reduced its lead times to increase the speed to market.  However, the new apparel products launched during the quarter were relatively expensive and failed to attract sufficient store traffic. 
Most of Abercrombie’s customers are teenagers who are dependent on their parents for money. Since the payroll tax hike and higher unemployment rate has hurt the consumer spending in the U.S., the teenage shoppers are left with less to spend. The unemployment rate in the U.S. teenage segment (23.7% July) is one of the highest among large economies, and it is unlikely that this demographic will spend much on Aeropostale’s new more expensive apparel.   Additionally, a fickle customer base has also hurt the retailer’s results as customers move to other low-cost, fast-fashion brands such as Zara, Forever 21 and H&M.  
Store Consolidation May Help The Pofitability Going Forward
Aeropostale operates over 1,000 stores in the U.S. and Canada and has been expanding steadily over the past few years. However, since the company is struggling to improve its sales, it is now looking to improve its profitability by closing underperforming stores. At the start of fiscal 2013, the company had planned to close about 15-20 stores by the year end. Half way through the year, it increased this figure to 30-40. 
This strategy has helped a number of retailers such as Abercrombie & Fitch, American Eagle Outfitters and Gap Inc. (NYSE:GPS) and might work for Aeropostale as well. American Eagle closed 44 stores during 2009-2012, which helped its EBITDA per store increase by almost 30%. Even Gap Inc. has seen similar results with its store consolidation. Although this strategy will weigh on Aeropostale’s revenue growth initially, it should have a positive impact on revenue per square feet and EBITDA margins over the longer run. This is essential for the retailer given that its revenue per square feet has been declining and its EBITDA margins are quite low as compared to its peers.
E-Commerce Growth Provides Some Hope
Despite the weak results, Aeropostale managed to post strong growth in its e-commerce business. Driven by the appealing product offerings of GoJane.com and the new Live Love Dream brand, the channel’s revenues increased by 22% in Q2 fiscal 2013. During the quarter, Aeropostale launched the Live Love Dream collection online featuring active tops and pants, yoga, lounge, intimates and footwears, which saw good acceptance among customers. 
Aeropostale’s direct business has been growing at a rapid pace with almost 120% growth coming in the last four years. We expect this trend to continue in the future driven by the optimistic outlook of the online apparel industry and the retailer’s own efforts on this front. Aeropostale has invested in e-commerce technology for order management, product fulfillment and customer service, which has helped it reduce shipping and handling costs. It offers a larger product variety over the Internet and leverages mobile and social commerce channels to attract customers. The company is particularly focused on its mobile channel as sales via smartphones are expected to account for 9% of total online retail sales in the U.S. by 2017, up from 3% in 2012. 
Although this business is small, it serves as a valuable channel for Aeropostale to interact with its teenage customers. According to a piper Jaffray survey, about 70% of the teenage customers prefer to shop for their favorite brand online.  This suggests that Aeropostale can rely on its direct-to-consumer business for future growth provided it gets its fundamentals right and repositions its brand image.
Our price estimate for Aeropostale implies a significant premium to the market price. However, we’re in the process of updating our valuation in light of the recent earnings.Notes:
- Aeropostale’s Q2 fiscal 2013 earnings transcript, Aug 22 2013 [↩] [↩] [↩] [↩]
- Aeropostale Tries Makeover In Time For Back-To-School, Crain’s New York Business, Aug 11 2013 [↩]
- Aeropostale Latest Teen Stores To Post Weak Sales, abc News, Aug 22 2013 [↩]
- Teen Retailers Could Be In For Rough Back-To-School Season, The Wall Street Journal, Aug 6 2013 [↩]
- America’s Youth Nonemployment Rate Is One Of The Worst Of Wealthy, Large Economies, Huffington Post, May 5 2013 [↩]
- Electronics, int’l ‘fast-fashion’ rivals squeeze top US teen chains, GMA News, Aug 22 2013 [↩]
- Abercrombie & Fitch’s Q2 fiscal 2013 earnings transcript, Aug 22 2013 [↩]
- M-Commerce sales via smartphones hit $8 billion in 2012, Internet Retailer, Jan 16 2013 [↩]
- Taking Stock With Teens, Piper Jaffray, Apr 10 2013 [↩]