Aeropostale’s Fall To Continue; Restoration Efforts In Focus

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ARO: Aeropostale logo
ARO
Aeropostale

Teen apparel retailer Aeropostale (NYSE:ARO) is struggling and under significant duress. Its stock is down almost 95% since 2010, on account of poor financial performance and there has hardly been any sign of improvement in its reported results over the past several quarters. The retailer is scheduled to release its Q2 fiscal 2015 results on Aug 27th and, based on its second quarter guidance, it appears that the company has yet to turn the quarter. After reporting weaker-than-expected profits for the first quarter of fiscal 2015, Aeropostale guided its second quarter loss per share at $0.52-$0.60, much worse than analysts’ estimates. [1] The second quarter includes the start of the crucial back-to-school season and Aeropostale’s guidance clearly indicates that it does not expect much from its season-relevant inventory.

We believe that the company’s overall performance in the U.S. likely remained poor in the second quarter due to a consistent decline in foot traffic and hefty promotional activities. However, Aeropostale has seen some latent signs of improvement over the past couple of quarters in the form of a marginal rise in average prices and gross margins. Hence, it is worthwhile to focus on a few factors in the upcoming earnings, that are expected to counter the decline in the company’s revenues going forward.

Due to the infusion of fashion-fashion forward inventory in its portfolio, Aeropostale has seen a small decline in the level of promotional activities. Consistent progress on this front, coupled with better customer response, can help the retailer record some notable improvement in the long run. The company had reduced its P.S. from Aeropostale store count to 26 in the first quarter of 2015 in order to re-position the brand from malls to off-mall locations. It is likely that the retailer would have started opening P.S. stores at other locations during the quarter, as it ultimately plans to grow this concept to 500 stores. Also, Aeropostale recently announced plans to expand into India and Indonesia through licensee agreements, a move that can compensate for the lack of growth in the U.S. in the long term.

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Our price estimate for Aeroposatle is at $3.29, implying a significant premium to the current market price.

See our complete analysis for Aeropostale

Decline In Foot Traffic & Heavy Promotions To Pummel Growth

Aeropostale isn’t the most preferred shopping destination as such, and the gradual shift from store to online shopping is making things worse for the company. Due to this shift, store traffic across the market has declined significantly over the last couple of years. The rate of decline has been in mid- to high single digits in most of the months. U.S. store traffic declined almost 10% year over year in May and in June it was down 6.1% annually and 7.6% sequentially. [2] In July, traffic declined a sharp 11% year over year and, despite 4.7% growth in average sales per shopper, overall retail sales fell 6.8%. [3] Given that Aeropostale is among the weaker players in a struggling industry, it is highly unlikely that it was able to overcome the market weakness. In fact, due to consistently falling foot traffic and lack of a strong fashion component in its portfolio, the retailer has been generous with its discounts. This has further suppressed its revenue and profit growth.

Rise In Average Prices Can Imply Progress On Merchandise

Aeropostale’s product portfolio is heavily lopsided towards basic logo merchandise, which aren’t attracting U.S. buyers anymore. However, in response to the change in the consumers’ buying preferences, the retailer has been aggressively infusing fashion to its merchandise range, hoping to garner higher customer attention. While the retailer hasn’t seen any notable success with this strategy, there have been some signs of improvement. Following four years of mid-single digit declines, Aeroposatle’s average unit prices increased 5% in 2014, driven by better customer response to fashion lines such as Bethany Mota, Pretty Little Liars and Tokyo Darling. However, the retailer lost this momentum in the first quarter of 2015, as average unit retail prices remained flat year-over-year. On the other hand, its gross margins expanded 70 basis points year over year, indicating a slight ease in discounting. These factors clearly imply the sluggishness in Aeropostale’s progress on the merchandise front. Given its duress, it is extremely imperative for Aeropostale to get its merchandise in line with prevailing customer preferences. Therefore, we will be keenly watching its average unit retail prices and gross margins in the upcoming quarterly results.

P.S. Store Count Might Have Started Increasing

In the wake of dwindling mall traffic, Aeropostale had decided to close all its P.S. from Aeropostale mall based stores, to reopen them in lucrative off-mall locations. From 151 in 2014, the company reduced the brand’s store count to just 26 in Q1 fiscal 2015. While such a drastic reduction in store count would have had a significant negative impact on Aeropostale’s Q2 revenues, it is important to monitor P.S. from Aeropostale’s progress from a long term perspective. The brand has immense growth potential, and the company wants to eventually make its presence in the U.S. comparable to its mainline brand. We believe that Aeropostale likely started opening P.S. stores at desired locations in the second quarter, as it does not want to delay the process any further. However, given that the company does not have much cash on hand and is struggling to raise capital in the public markets, it will be interesting to see how it plans P.S. from Aeropostale’s expansion.

International Expansion Holds Some Promise

Considering the highly fragmented nature of the U.S. apparel industry, there isn’t much left for Aeropostale to explore in its main market. Hence, it makes sense for the company to tap opportunities in lucrative international markets, where competition is less intense. The retailer recently announced plans to expand into India and Indonesia through licensing deals. Beginning March 2016, Aeropostale plans to open 50 standalone stores in India over the course of the next five years along with 150 shop-in-shop locations and e-commerce operations. In Indonesia, the retailer is eyeing just 10-12 standalone stores. By the year end, Aeropostale expects to have over 300 locations across 17 countries bringing in licensing revenues. [4] However, they won’t be enough to offset the retailer’s domestic weakness any time soon. Nevertheless, international expansion through licensee agreements isn’t capital intensive, doesn’t have store related expenses and helps tremendously in brand building. At the moment, these factors work in Aeropostale’s favor and, hence, licensee expansion appears its best bet for international markets.

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Notes:
  1. Aeropostale Reports Results For The First Quarter of 2015, Aeropostale, May 21 2015 []
  2. Brick-and-Mortar Traffic Decline Slowed in June, Sourcing Journal, Jul 14 2015 []
  3. RetailNext: Fewer shoppers but more commitment in July, Chain Store Age, Aug 6 2015 []
  4. Aeropostale Continues Aggressive Expansion In Asia With New Licensing Agreements In India And Indonesia, Aeropostale, Jul 2 2015 []