Aeropostale’s Underlying Concerns Escalate Following Another Dismal Quarter

As expected, Aeropostale (NYSE:ARO) reported lackluster quarterly results yet again, marking its eleventh consecutive quarter of net losses. Its revenues fell 17.5% to $327 million with loss per share at $0.55, both missing the average analyst estimate. ^[1] The more disappointing factor, however, was that were not any latent signs of recovery in the company’s performance. Its average price per unit fell drastically after stabilizing in Q1 and P.S. from Aeropostale’s store count remained at 26, while we expected it to increase. It appears that Aeropostale’s infusion of fashion-forward products in its portfolio is not showing much promise, as discounting remains the main traffic driving factor. For P.S. from Aeropostale, the retailer’s weak financing capacity seems to be restricting the brand’s expansion, which raises several concerns around its only lucrative business prospect. Keeping in mind what has transpired in the recent quarter, we have lowered our price estimate for Aeropostale by over 30% by making certain adjustments to its revenue per square feet, store count and EBITDA margin forecasts.

Aeropostale said that heavy discounting of older inventory was the main reason behind the decline in its average prices, and they are confident about their back-to-school inventory. However, the retailer’s guidance for the third quarter suggests otherwise. The company expects to report a loss per share of $0.30-$0.38, worse than the consensus estimate of $0.31. While U.S. buyers’ shift towards fast-fashion brands and online shopping has troubled the entire casual apparel industry, the impact on Aeropostale has been particularly intense. And there seems to be no end for the company’s troubles, as the factors that were supposed to help it recover are not fulfilling their promise.

Our revised price estimate for Aeroposatle is at $2.22, implying a significant premium to the current market price.

See our complete analysis for Aeropostale

Continued Fashion Failure Can Suppress The Company’s Value

Similar to what other casual apparel retailers are doing to survive the growing threat from fast-fashion companies such as Zara and Forever 21, Aeropostale is trying hard to increase its reliance on fashion-focused merchandise. After its initial attempt failed terribly, the retailer saw some success for its Bethany Mota, Pretty Little Liars and Tokyo Darling collections, as average prices per unit increased 5% in 2014. However, this was short-lived. The metric fell flat in the first quarter of 2015 and declined a sizable 7% in the second. Aeropostale attributed this decline to its strategic inventory cleansing process, which indicates that it is still heavily reliant on logo merchandise despite several robust efforts. ^[2]

Even if Aeropostale succeeds in overhauling its portfolio with fashion-relevant products, its long standing “cheap-basic” brand image will make customers confused about the retailer’s updated version. The company has seen positive buyer response in bits and pieces, but there has not been any notable improvement in customers’ perception. Going forward, Aeropostale is trying to find a better balance between contemporary and classic clothing, so as to better cater to teenager’s fickle shopping behavior. However, given the retailer’s recent history with fashion and basic merchandise, success in the near term appears highly unlikely.

We previously estimated the company’s revenue per square feet to decline slightly this year to $435 and begin increasing thereafter to reach $462 over the next five-six years. However, prompted by Aeropostale’s failure to arrest the decline in its average unit retail, we have lowered the long term forecast to $437. This lowers our price estimate by about 10%. Simultaneously, we have lowered the Aeropostale’s long term EBITDA margin figure from 12.1% to 11%, which accounts for about another 15% downside to its value.

P.S. From Aeropostale May Expand Slower-Than-Expected

Aeropostale had decided to move all its P.S. from Aeropostale locations from malls to off-mall locations to accelerate the concept’s same-store sales growth. While the company reduced its kids brand store network rapidly to 26 outlets at the end of Q1 2015, it did not open any store in the recently concluded quarter. Considering that the company plans to ultimately grow the concept to over 500 stores, this does not look promising. Aeropostale has just $86 million in cash and cash equivalents, with a debt of over $142 million and contractual lease obligations in excess of $500 million. The company’s balance sheet is weak and it has not generated profits since 2012, which is why it does not have the capital capacity to invest in store expansion.

Therefore, we believe that Aeropostale will expand its P.S. format at a slower pace than expected. We had estimated Aeropostale’s total store count to decline from 860 in 2014 to around 800 in 2016, on account of continued consolidation of mainline brand and decline in P.S. store count.  We had projected the figure, thereafter, to increase to 930 over the next four-five years. However, with slower than expected expansion, we project the store count to reach just 900 by the end of the forecast period, which brings about a 5% downside in Aeropostale’s price estimate.

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1. Aeropostale Reports Results for Second Quarter of Fiscal 2015, Aeropostale, Aug 27 2015 [↩]
2. Aeropostale’s Q2 Fiscal 2015 Earnings Transcript, Aug 27 2015 [↩]