Aeropostale May be Headed Towards A Turnaround With The Rightsizing Of Its Domestic Store Fleet
With its affordable basic products, Aeropostale (NYSE:ARO) was one of the strongest apparel performers during the recession of 2008 to 2009. However, as the economy started recovering, the retailer failed to take advantage of rising consumer interest in fashionable apparel due to its persistent focus on the logo business. Aeropostale unintentionally drove its customers to other fashion forward brands such as Gap Inc (NYSE:GPS), Abercrombie & Fitch (NYSE:ANF), Urban Outfitters (NASDAQ:URBN) etc. When the company realized that it was time to boost its product portfolio with greater fashion variety, an unfavorable economic environment and a “not-cool” brand perception undermined its efforts. As a result, Aeropostale’s sales declined 17% and its stock stumbled by more than 50% during 2010-2013.
With its stock price at an all-time low, several investors have raised their stake in the company hoping for a turnaround in the future. We believe that Aeropostale’s efforts to downsize its namesake store network and expand its P.S. from Aeropostale brand are likely to play a pivotal role in its revival. In order to reduce its expenses and generate better sales per square feet, the company is looking to close a number of its under-performing stores in the U.S. While this will impact Aeropostale’s revenue growth, key metrics, including revenue per square feet and EBITDA margins, can improve gradually. In addition to consolidating its mainline store network, the retailer is aggressively expanding its relatively new and successful P.S. from Aeropostale concept. Currently, P.S. from Aeropostale‘s store count is significantly lower than that of Aeropostale’s, but this difference is likely to come down in the future. Under such a condition, P.S. from Aeropostale will become strong enough to make a material contribution to the company’s results and make its recovery a lot easier.
Our price estimate for Aeroposatle is at $9.20, implying a premium of about 70% to the market price.
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Reducing Mainline Store Count To Improve Profitability
Aeropostale stores are mainly located in shopping malls, where foot traffic has been weak over the past several quarters on account of weak consumer confidence. Moreover, shoppers have eluded the brand’s basic logo products in search of more fashionable merchandise offered by other retailers such as Gap Inc and Urban Outfitters. As a result, Aeropostale hasn’t been able to drive sufficient store traffic, which has led to heavy markdowns and promotions. This has weighed heavily on its revenue per square feet, operating margins and cash profits. The company’s revenue per square feet has declined by close to 30% over the last three years and its EBITDA margins have crashed by almost 20 percentage points.
While Aeropostale is trying hard to increase the proportion of fashionable products in its portfolio with collections such as Pretty Little Liars, Bethany Mota and Live Love Dream, it is also looking to cut its operating costs. The company has accelerated the closure of its under-performing namesake brand stores to improve its overall store productivity. At the start of fiscal 2013, the company had planned to close about 15-20 stores by the year-end, but it increased this figure to 30-40 half way through the year. In Q4 alone, Aeropostale shut down 29 stores. Over the next several years, the retailer plans to close 175 stores in the U.S., which will bring the store count down to around 750.
Closing stores that do not generate significant traffic can have a slight positive impact on Aeropostale’s revenue per square feet. It can also help the retailer reduce its operating expenses and improve operating margins. Moreover, this strategy will allow Aeropostale to utilize its capital expenditure better. Together, these aspects can improve the cash flow generation, which is an absolute necessity for Aeropostale considering that it is burning up cash fast and is having difficulty in raising capital in the public market.
Expanding P.S. From Aeropostale To Make It A Sturdy Growth Driver
In 2009, Aeropostale launched a new retail concept called P.S. from Aeropostale, which offers casual clothing and accessories for kids in the age group of 4-12 years. While the retailer’s mainline business has struggled post-recession, this brand has performed very well. This can be attributed to the fact that competition in the pre-teen apparel market isn’t as intense as in the teen apparel market, and consumer spending on clothing is relatively stable in the preteen or tween space.
Although there are several established apparel retailers in the U.S., most of them focus on teenagers and young adults due to their preference for apparel shopping. This has made the pre-teen apparel market somewhat niche and safe to enter. Moreover, unlike the teen apparel space, where buyers often rely on their own income, kids are dependent on their parents for apparel shopping. In the current economic environment, employment scenario for adults (who earn higher) is much better than it is for teenagers, implying that adults have a higher budget for apparel and accessories.
Due to the aforementioned factors, it makes sense for Aeropostale to continue expanding P.S. from Aeropostale aggressively. The company opened 29 brand stores in 2012 and accelerated the expansion rate in 2013 with the addition of 51 stores. As of fiscal 2013, the retailer had 151 P.S. from Aeropostale stores across 20 states in the U.S., leaving another 30 states untapped. Given the brand’s success, it won’t be surprising if its geographical reach is extended in the near future. Aeropostale’s management has stated that its P.S from Aeropostale concept will ultimately grow to 500 stores and render $700 million in incremental revenues.
In the long run, Aeropostale’s mainline store count is likely to come down to 750 and its P.S. brand is expected to have a network of 500 stores. This formulates a very interesting scenario where P.S. from Aeropostale will become strong enough to drive the company’s results. Combining this with Aeropostale’s rigorous efforts to revamp its mainline business, we conclude that the company is headed towards a turnaround. That said, it still remains to be seen whether Aeropostale’s turnaround will be as a public company or a private company.
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