Aeropostale: An Unlikely Turnaround With Insider Buying, Multi-Bagger Potential

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Jul 23, 2015
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Aéropostale, Inc. (ARO, Financial), often referred to as Aéro, is an American mall-based teen retailer. Therefore, it's probably the most out-of-favor type of investment out there. It targets teens through its Aéropostale stores, and younger children (or more accurately, their parents) through its P.S. from Aéropostale stores.The Company operates 766 Aeropostale stores in 50 states and Puerto Rico, 61 Aeropostale stores in Canada and 26 P.S. from Aeropostale stores in 12 states and Puerto Rico. Licensees (the company takes no risk on these but gets a cut of the revenue) operate 239 Aeropostale and P.S. from Aeropostale locations in the Middle East, Asia, Europe, and Latin America. Aeropostale, Inc. also operates GoJane.com, Inc., an online women's fashion retailer.The first Aéropostale store opened up shop in 1987 by Macy's in Los Angeles, CA. Aéropostale competes directly with Abercrombie & Fitch and subsidiary Hollister and American Eagle. Recently share price performance has been subpar to say the least:

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Financial status

The financials are a mess. The company has $150 million in debt and $75 million in cash. In addition, it has exposure to ~800+ store leases. The big problem it is burning a lot of money on a quarterly basis. Granted, the later quarters of this year should be better given seasonal patterns. Currently, the company is loading up on inventory in anticipation of the back-to-school season. It is all-in on this season. If it is a bust, It is likely Aeropostale’s stock is a bust as well. If this is a big success inventory will go down a lot and liquidity will greatly improve alleviating at least some market concerns. On the financial front, things are very precarious.

Management

Julian Geiger returned to the company at the end of 2014. He managed the company during an earlier successful period from 1996 to February 12, 2010 and has been a member of the board until 2012. He has now taken on the challenge to restore Aeropostale to its former glory. He did make several modest open market purchases after the last earnings call. Another thing to note is that Executive VP Emilia Fabricant, who was responsible for the company's merchandising strategy, just left after being at the company for only a short while. Having said that, she is currently employed at Kate Spade (KATE). Kate Spade is a lot cooler and more succesful, so it is possible she just got an offer she could not refuse. The broad insider buying is a highly positive sign:

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image: table 1.

It reminded me of a Peter Lynch quote. I grabbed my copy of One Up On Wall Street to find it:


When insiders are buying, I'd bet there aren't three companies in history that have gone bankrupt near term.

Risks

Risks with Aeropostalé are great. It is not unfathomable that in six months, the company went into chapter 11 somewhere along the way (the insider buying and Peter Lynch quote do not entirely reassure me). The company is heavily indebted and confronted with lots of expenses. It is saving money by decreasing CapEx, but it is hard to say how sustainable that is going to be. Customers have turned away from Aeropostalé already, but if the fresh design philosophy (less logo centric for example) put into practice does not resonate with them, that can kill the company by cratering revenues. The operating leverage present in retail chains will do the rest. The reason I am writing up Aeropostalé nonetheless will become clear in the valuation paragraph. I cannot stress enough that there is a lot of risk in this investment.

Valuation

Valuation and outlook are key when considering Aeropostalé. What makes an investment into Aeropostalé so tempting is the stock price versus the potential free cash flow per share if management succeeds turning the company around. The team thinks it has a shot as evident by the insider trading in table 1.

The whole sector struggles and Aeropostalé’s main competitors may not have to deal with problems to the same extent, their operating margins are at or near historical lows as well.

Aeropostalé is in so much trouble that it is hard to find a positive metric to try and illustrate the potential here. I will have to revert to the metric reserved for unprofitable companies; price-to-sales. As much as I hate it, I do not really have something better to easily show how negative the Street is on the short term fate of the company.

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Its competitors are not trading at lofty sales multiples themselves at just 1.1x and 0.4x. Obviously, the Street is not bullish on the future of the sector. Ok, that is fine. Let’s say there is going to be little growth going forward, competition remains high and margins thin. At most, the company would deserve a 0.4x multiple like Abercrombie and Fitch once it accomplishes something resembling a turnaround. That is still a four-bagger from current levels. Even if it manages a turnaround only after closing so many shops its revenue is cut in half, or dilutes current shareholders by 50%, it is still a potential double if it rerates to a 0.4x multiple.

This goes to illustrate how much of a lottery ticket type of stock this is at the moment. The possibility that Aeropostalé will enter chapter 11 is high. The market clearly thinks it is the more likely outcome versus a recovery. Alternatively, there are many scenarios to imagine where Aeropostalé muddles through and ultimately survives. Will there be dilution? Will there be no dilution? Could the company achieve operating margins of 10% at some point. If the company enters chapter 11, investors will lose their investment, but if it muddles through, Aeropostalé will most likely be a multi-bagger from this level.

Interesting segment

One very important segment to be aware of is the International licensing business which continues to expand. I am under the impression the team is pushing this licensing business pretty hard. The licensing business is only a drop in the bucket revenue wise, but it is getting meaningful in terms of bottom line contribution. Licensing revenue has very few costs associated with it. The company takes no execution, inventory or merchandise risk on these licenses, but gets a cut of the revenue. In addition, the licensees are predominantly located in high GDP growth areas of the world.

At the end of 2014, licensees were running 239 Aéropostale and P.S. from Aéropostale stores:

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Aéropostale recently made another deal with Arvind Lifestyle Brands Limited (India) and with PT Mitra Adiperkasa TBK (Indonesia). In total, the two deals should add 60+ standalone stores and 150 shop-in-shop locations to the International footprint over the next five years.

Another recent deal was made with the Apparel Group. That company will open another 25 Aéropostale stores and 38 P.S. from Aéropostale stores over the next five years. Note that is likely to result in a 25% revenue increase from licensing. Another deal that is not visible in the numbers above is with Shoesforyou. Shoesforyou is taking the brand to Ireland although it is not clear how many stores it will open with the Aéropostale brand.

Geiger stated in a press release:

We anticipate ending the year with over 300 locations across 17 countries. Our aggressive international growth underscores the strength and recognition of the Aeropostale brand, and we look forward to announcing new global licensing partnerships throughout the year.

The growth rate of the licensing business is pretty amazing, from $7 million in 2012 to $35 million in 2014. The CEO’s comment in the press release indicate this number could increase by something like 25% YoY, and the already announced expansions put the licensing business on track to achieve similar kind of growth over the years after that as well.

Outlook: Aeropostale is all-in on "Back to School"

Julian Geiger has expressed in no uncertain terms that the company is all-in on the Back to school season (most recent earnings call, emphasis mine):

One of the operating imperatives we have established for the second quarter is to enter the back-to-school selling season, with extraordinarily high levels of merchandise currency, so that the new assortment we've created and discussed so optimistically has the ability to reach its full potential.

As I have said previously, we expect that the back-to-school period will represent a time when all of our efforts over the last nine months to change the trajectory of our business should come to fruition. As such, our performance in August will be a leading indicator of how we feel we will do during the remainder of the third quarter and into fourth quarter.

I am confident that we will be in a position to win because I believe that the structural changes we've made to our organization will pay dividends in our store performance as it already has in the e-commerce area, which includes GoJane; that we've created a relevant and outstanding merchandise assortment, that we've updated our promotional playbook to create demand, that we have new and exciting marketing ideas to tell our story, that we are leveraging social media influences to underscore the compelling nature of our brand, that we have made dramatic improvements in the manner in which we will be allocating merchandise to stores and that the rigorous testing disciplines we have instituted will give far greater insights into customer preferences. The contribution made by the sum of all of these changes in conjunction with the maniacal focus on merchandise currency should be the springboard to significant financial progress.

When you are fighting for survival and liquidity is by no means a sure thing, merchandise has not resonated with customers, it is very gutsy to double down on inventory and stake the fate of the company on the next season. Yet, the team is buying shares on the open market and it looks like it really believes they can pull it off.

The back to school season is so crucial to the fate of Aéropostale that the company rescheduled the next earnings call ahead of time so the team can provide meaningful updates on how the back-to-school event progressed.