Aeropostale Will Recover as a Serious Competitor in Apparel

Aeropostale’s (NYSE:ARO) stock may be well worth the investment despite dismal Q2 sales. The company has certainly seen better days, having lost much of its market to leading competitors such as Abercrombie & Fitch (NYSE:ANF), American Eagle Outfitters (NYSE:AEO), and Urban Outfitters (NYSE: URBN) among others. Aeropostale specializes in clothing and accessories and targets teenagers and young adults. The competition in the apparel industry is incredibly fierce with many top competitors yearning for their share of the market. Aeropostale’s stock has taken a beating over the past few months, dropping from $25.49 on May 4th to the current price of around $11.25. We expect Aeropostale to bounce back strongly in the coming quarterlies and are predicting an approximate increase of 150%.

See our full analysis for Aeropostale.

What Caused The Plummeting Stock Prices

There are a number of factors that contributed to the severe decrease in Aeropostale’s stock. Possibly the biggest contributor was the rising cotton prices. Although the increase in cotton prices affected virtually every apparel company over the past year, companies like Aeropostale were hit especially hard. Companies like Aeropostale strive to provide fashionable clothing at a reasonable price. Much of their appeal to teenagers comes from undercutting the prices of more prestigious brands like Abercrombie & Fitch. As cotton prices soared to $2.30 in March 2011, many companies chose to pass on the costs to the consumer in the face of such economic difficulties. Aeropostale was unable to respond to the sky-high cotton prices in this manner without compromising its business model.

With production cost higher than normal, Aeropostale was unable to maintain its image as a promotional teen retailer. Its competition quickly scooped up market share by offering the very types of promotional offers and discounts that initially attracted people to Aeropostale. Aeropostale was forced to act, adding numerous discounts and offers. This caused an increase in costs and a decrease in profit margins.

How We Justify Such a Brazen Estimated Increase

Although Aeropostale is struggling to regain its footing, the news is certainly not without its advantages for investors. The time may be just right to invest in Aeropostale as we expect this popular company to gain back this market share over time. Although many consumers are choosing to shop at Aeropostale’s competitors, it’s important to remember that brand loyalty doesn’t hold much value in a market where virtually all major teenage apparel companies are seen as trendy.

The price of cotton soared due to the drought in the Hubei province of China as well as flooding in Pakistan and exporting restrictions in India. China, being the highest producer of cotton in the world, plays an enormous role in determining the current price. As Chinese crops have returned to normal, cotton prices have already started to return to their previous value.

Cotton prices have been dropping rapidly since March 2011 and are currently below $100, down over 50% since March this year. We expect the price to continue to drop throughout 2011, leading to favorable conditions for Aeropostale. While other companies are likely to continue as normal, Aeropostale will be given the chance to bounce back because of its ability to offer more discounts and promotional offers. As the price of cotton returns to normalcy, we expect Aeropostale’s stock to do the same.

This can be seen from our predicted EBITDA margins over the next few years. Although we estimate that Aeropostale’s EBITDA margins dropped from 18.4% to 8.35% between 2010 and the present, we expect its margins to steadily increase to around 10.5% over our forecast period.

What if the Price of Cotton Doesn’t Decrease?

Even if cotton prices don’t continue to drop, we still believe that Aeropostale will recover, albeit not to the extent that we have predicted. Aeropostale has a history of resiliency and is sure to compensate for its poor margins. During the recessionary period, Aeropostale managed to significantly increase its revenue per square foot, despite many competitors being unable to do likewise. If the price of cotton doesn’t return to normal – a situation that we think is quite unlikely – Aeropostale will undoubtedly increase margins by passing off costs to the consumer. Although this situation is undesirable for Aeropostale, it is likely that it will do whatever is necessary.

Although a strong decrease in cotton prices is surely imminent, we believe that Aeropostale’s stock will slowly return to normal even if the decrease doesn’t occur. This puts Aeropostale in the spotlight, as investors vie to know what will happen over the next year. This is one company that shouldn’t be ignored.

We have an $18.75 price estimate for Aeropostale, which is around 35%% above the market price.

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