Two Scenarios That Can Impact Aeropostale’s Valuation Significantly

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ARO: Aeropostale logo
ARO
Aeropostale

Aeropostale (NYSE:ARO) has struggled to keep its business going ever since the U.S. economy started recovering. The company’s market value has declined almost 90% since mid-2012 and is currently worth less than $2 per share. Our price estimate for Aeroposatle is at $3.29, which is about 80% premium to the current market price. We believe that the company can show some recovery going forward as it looks to improve its product portfolio and expand its P.S. from Aeropostale store base. In this analysis, we discuss a couple of plausible scenarios that can impact Aeropostale’s valuation significantly.

As a revival effort, the retailer is looking to shift its P.S. from Aeropostale brand from malls to off-mall locations. There exists the possibility that the company can expand this format rapidly in the future, which can even push its overall revenue per square feet and margins up. If such a scenario were to unfold, it would bring about a positive change in Aeropostale’s price estimate. On the other hand, the company’s value may diminish if its efforts for improving its product portfolio do not yield the desired results, leading to a weaker-than-expected recovery in overall EBITDA margins.

See our complete analysis for Aeropostale

Rapid P.S. From Aeropostale Store Expansion (+30%)

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Although U.S. apparel retailers are no longer interested in expanding their store base, thanks to the adoption of omni-channel retailing, Aeropostale has a concept that still needs to expand significantly. The company’s kids business — P.S. from Aeropostale — is currently limited to just 26 stores, thanks to its decision of closing all the mall locations to reposition the brand’s store fleet to more lucrative locations. Our current forecast for Aeropostale’s overall store count incorporates the fact that it is consolidating its mainline business and expanding P.S. from Aeropostale simultaneously. We currently forecast that Aeropostale’s store count will decrease over the next two years dominated by mainline store consolidation, and increase gradually thereafter to around 930 by 2021. 930 represents a combination of around 720-750 mainline brand stores and 180-200 P.S. from Aeropostale stores.

However, Aeropostale has mentioned in the past that it eventually wants to grow its kids brand concept to around 500. Hence, it is likely that the brand’s expansion in the near term will be much faster than our forecast. For this scenario, we increase the overall store count forecast to 1,050 instead of 930, which means that P.S. store count will be around 300-330. Since the contribution of P.S. in the retailer’s overall business will increase, it can have a positive impact on overall revenue per square feet and margins. This is since it is a better performing business. Accordingly, we elevate the revenue per square feet forecast at the end of our forecast horizon from $462 to $476, and raise EBITDA margins from 12.0% to 13.1%. In order to expand the store base rapidly, Aeropostale will have to increase its capital expenditure and, hence, we increase our long-term capex as percentage of EBITDA forecast from 45% to 48%. The increase in this metric is only marginal since EBITDA will also increase along with capital expenditure. If the aforementioned scenario unfolds, it can result in an upside of 30% to our price estimate for Aeropostale. The only thing that hinder this scenario is Aeropostale’s lack of cash and weak credit rating.

Weaker Recovery In EBITDA Margins (-40%)

Aeropostale’s EBITDA margins were at 2% at the end of 2014, due to heavy discounting, high store operating expenses and an insignificant contribution from the lucrative P.S. from Aeropostale business. Before its struggle started, the company was generating a EBITDA margin of over 26%. With the ongoing shift in consumer tastes and spending patterns and an increase in competition across the segments, Aeropostale is unlikely to see its margins anywhere near its historical levels, even if it successfully turns around its business. However, there will be some recovery going forward, with the growth of P.S. format, improvements in product portfolio, and the consolidation of under-performing stores. We presently estimate margins to increase from 2.1% in 2014 to 12.1% over the next five-six years.

If Aeropostale’s efforts to re-create its brand image and overhaul product portfolio fail to entice customers, it may have to persist with heavy promotional activities which can hinder margin recovery. In a scenario where the retailer’s EBITDA margins increase to just 11.1% in the long run instead of 12.1%, there can be about 40% downside to our price estimate for Aeropostale. This scenario is highly likely since the company’s efforts to introduce desired fashion in its offerings hasn’t seen much success so far, and this could very well continue.

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