Aeropostale Q3 Preview: Margin Remain in Focus

Teen specialty retailer Aeropostale (NYSE:ARO) is scheduled to announce its Q3 earnings results on November 30th, ^[1] and investors and analysts will have a keen eye on company’s gross margins. Earlier on November 3rd, Aeropostale’s stock gained over 20% after the company announced a revised earnings due to increase in expected gross margins. As gross margins are destined to take the center seat in this quarter’s earnings result, we will be watching for the trends behind the improvement in margins for Q3. Aeropostale competes with the likes of Abercrombie & Fitch (NYSE:ANF), American Eagle Outfitters (NYSE:AEO), Gap Inc. (NYSE:GPS) in the teen apparel space.

Trefis price estimate for Aeropostale’s stock stands at $18.74, implying an upside of nearly 25% to the current market price.

See our full analysis of Aeropostale

Margins to remain center of attention

Aeropostale’s stock had received a major boost on November 3rd, after the company had announced an improvement in expected margins for the quarters.

See our article : Aeropostale’s Shares Fly on Improved Margin Outlook, Tops Out at $18.75

With the disclosure of net sales and comp sales for Q3 in sales update on November 3rd, the focus has now centered around margins. While the improvement in gross margins compared to that of last quarter will certainly be worth noticing, we will be more keenly following the trends behind the margin improvement. Below we try to explore the probable reasons behind margin improvement for Q3:

1. Balanced Merchandise Assortments in Q3: Lack of balance in its merchandise was a major source of concern for Aeropostale during Q2. This had resulted in piling up of inventory and had forced the company to increase the depth of its promotions to clear off its growing inventory levels, resulting in a massive decline of over 10% in margins. Aeropostale had setting of proper balance in merchandise as its top most priority for this quarter, and we expect this to be a major driver this quarter.

2. Decline in Cotton Price: Though some analysts dismiss the increase/decrease in cotton prices as an industry wide phenomenon, we believe that cotton price is a very significant metric for value based companies such as Aeropostale as it cannot quickly pass the cost pressures to customers without compromising its business model. Cotton prices have decreased form nearly 160 cents/pound in June 2011 to roughly 110 cents/pound in October 2011, which we believe has helped Aeropostale to improve its margins this quarter.

3. Increase in Internet Sales: Increase in internet sales has also been an important agenda for Aeropostale this quarter. The company rolled out its international shipping this quarter, which has helped it to ameliorate its margins.

See our article: Aeropostale Rolls Out Global Shipping to Improve Sales & Margins

Internet sales carry nearly twice the margins compared to that of retail sales, and an increase in the share of internet sales to net sales can provide significant tailwinds to the margins. We saw this is an important trend in Black Friday holiday spending and this could provide a boost for the company.

Though we expect all the above three factors to positively impact the margins this quarter, we will have a keen eye for the amount with which each trend impact the margins. As it will eventually decide, whether the improvement in margins is a short term (limited to this quarter) or a relatively long term (expected to continue ahead) trend.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Aeropostale to announce Q3 earnings on November 30th, Source: Aeropostale IR [↩]