Aeropostale’s Price Estimate Revised To $3.29

Aeropostale‘s (NYSE:ARO) persistent struggle with its product portfolio is very well known across the industry. The once popular brand has seen customers rapidly shift to other basic and fashionable brands over the last couple of years. The retailer’s own fashion launches have been undermined by its long standing “cheap, basic” brand image. Heavy discounting and weak store and web traffic have not only weighed on Aeropostale’s revenue growth, but have also pummeled its EBITDA margins. Suppressed by heavy discounting, the company’s revenue per square feet fell from $628 in 2009 to $438 in 2014 and its EBITDA margins came down from 25.7% in 2010 to just 2.1% four years later.

Although we believe that the worst is behind Aeropostale now and its revenue per square feet and margins may have bottomed out, recovery in these metrics is likely to be painfully slow. While the retailer’s average prices increased last year, they fell flat in the first quarter despite a lucrative comparable period, signalling sluggish recovery in average unit retail. This has prompted us to revise our forecasts for Aeropostale’s revenue per square feet and EBITDA margins, which has resulted in a negative 46% revision in our price estimate. Due to the company’s weak cash position, a slight change in its revenue and margin drivers has brought about a significant change in our price estimate. The following paragraphs explain the model changes in detail.

Our price estimate for Aeroposatle is at $3.29, implying a premium of over 60% to the current market price.

See our complete analysis for Aeropostale

Lowered Revenue Per Square Feet Forecast

2014 was one of the worst years for Aeropostale as its revenue per square foot touched an all time low of $437. We believed that with the integration of fashion in its portfolio and better contribution from P.S. from Aeropostale after a few years, the company’s revenue per square feet would recover and gradually increase to reach $474 over the next five-six years. However, looking at how better fashion isn’t helping Aeropostale offset its weakness in basic logo portfolio, we have pulled our revenue per square feet forecast down. We now expect the figure to continue to decrease this year and improve slowly thereafter to reach $462 by the end of our forecast horizon.

We believed that Aeropostale’s fall had bottomed out in 2014 and with slightly higher proportion of full priced sales with better fashion, we thought it may be able to show some improvement in 2015. However, the improvement in the first quarter has been limited, which indicates that Aeropostale’s road to recovery is going to be extremely tough. Hence, we do not expect any significant increase in revenue per square feet. In fact, the company’s portfolio weakness would even weigh on its online growth. We have lowered our e-commerce growth forecast from a CAGR (compound annual growth rate) of 5% to 4%.

Lowered EBITDA Margin Forecast

Discounting at Aeropostale remains heavy across the board, though there has been a slight improvement in average unit retail. This indicates that the margins will increase going forward, but probably not as strongly as our previous estimate. The retailer’s EBITDA margins were at 2.1% in 2014, and we had earlier forecast the figure to increase steadily to reach 15% over the next five-six years, which would still have been significantly below 2009-2010 levels. Since the industry trends have changed considerably from when Aeropostale was among the strongest performers, it is almost certain that it will not be able to relive its glory days even with a successful turnaround. Now, thanks to the inability of fashion categories to make a notable contribution, we have lowered our EBITDA forecast moderately. We now expect margins to increase at a slower rate in the near term, before settling at around 12% by the end of our forecast period. This seems doable for Aeropostale, provided it successfully repositions its P.S. from Aeropostale brand and continues to launch affordable fashion merchandise that can offset its basic portfolio weakness.

Lower Cash

A significant portion of the price revision can be attributed to Aeropostale’s cash position at the end of the quarter. It just had $75 million in cash and cash equivalents at the end of Q1 fiscal 2015, as compared to $151 million at the end of the prior quarter. The company is consistently reporting loses and is finding it hard to raise capital in public markets. It is burning whatever cash it has rapidly, with a debt of $140 million already on its balance sheet. Aeropostale has used up about $75 million cash in a single quarter, which has severely hit its market value as well as our price estimate.

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