AEROPOSTALE INC ARO
July 01, 2010 - 4:53pm EST by
beep899
2010 2011
Price: 30.50 EPS $2.27 $2.83
Shares Out. (in M): 95 P/E 11.9x 10.8x
Market Cap (in $M): 2,800 P/FCF 0.0x 0.0x
Net Debt (in $M): -313 EBIT 383 447
TEV ($): 2,594 TEV/EBIT 0.0x 0.0x

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Description

Aeropostale (ARO) is specialty apparel retailer of promotionally priced (low price) teen apparel. It has delivered positive same store sales and earnings leading up to the recession, throughout the recession and has continued to do so since the economy bottomed. In spite of these solid fundamentals the stock trades at much too low ev/ebitda multiples of 5.5x trailing, 5.1x 2010 and 4.8x 2011. These multiples are on Street estimates, estimates I believe are too low. The stock trades at $30.50.

Applying a peer 6.2x ev/ebitda multiple (current multiple for ROSS and TJX) to FY2011 (Jan 2012) Street EBITDA yields a $42.00 stock, respectively, and 46% upside over the next 12 to 18 months. Although ROST and TJX are off-price retailers of brand name over-runs and ARO is a genuine specialty retailer (designs its own clothing), I believe ARO’s promotional nature and ability to perform well in a recession make the three good comps for each other.

In spite of consistently strong comps and return on equity that beats its peers, ARO trades at multiples associated with an out-of-fashion, poorly managed retailer than can’t deliver in the kind of economy we have now because the Street thinks that as the economy recovers parents will return to their “old normal” spending habits and will re-direct their children away from the likes of Aeropostale and send them back to Abercrombie and Fitch (ANF) where the cost of a top or jeans is 2x to 3x that of ARO. This worry is misplaced as I believe the “new normal” characterized by chronic unemployment and underemployment, underwater houses and retirement funds, and parents worried about how to pay for college is here to stay for the foreseeable future. As the Street comes to see these economic trends persist they will begin to see that ARO is part of the long term solution for parents to clothe their children at a decent price but with enough teen cool factor that the kids will wear the clothes.

It is worth noting that the market had the same concern regarding off price retailers, Ross Stores (ROST) and TJ Maxx (TJX). The thinking was that as the economy recovers shoppers are going to rush back to paying full price at specialty retailers. However, perceptions are already beginning to change and the Street is increasingly viewing  ROST and TJX as new shopping mainstays for a wider slice of shoppers. As I have noted, I believe the same will happen for ARO.

ARO is cheap on both absolute and relative terms, has a market cap of $2.8B, is debt free, has $313M in cash on the balance sheet and has higher returns than its peers.

EV/EBITDA

TTM

2010

2011

ROE (%)

ARO

5.5

5.1

4.8

57.21

ROST

6.2

5.8

5.6

43.59

TJX

6.2

5.9

5.5

49.71

AEO

4.5

4.0

3.6

10.75

ANF

5.6

4.7

4.0

5.05

GPS

4.0

4.1

3.9

25.17

         

 


 

ARO has delivered 13 straight years of positive comps including throughout the recession:

 

Feb

Mar

Apr

May

Jun

Jul

Aug

Sept

Oct

Nov

Dec

Jan

2010

7.0

19.0

-5.0

1.0

               

2009

11.0

3.0

20.0

19.0

12.0

6.0

9.0

19.0

3.0

7.0

10.0

6.0

2008

7.0

2.5

25.0

6.0

12.0

13.0

13.0

5.0

1.0

-5.0

12.0

11.0

2007

2.3

15.9

-14.0

1.9

0.2

-11.9

1.7

1.3

3.0

6.6

12.2

4.7

                         
                         
                         
                         
                         
                         
                         

 

 

ARO’s unit pricing ($ per clothing item) is lower than peers:

 

ARO

PSUN

AEO

ANF

Hollister

Juniors graphic tees

10

10

10

24

16

Juniors denim

20

28

35

60

30

Guys graphic tees

10

20

12

30

10

Guys denim

20

28

35

60

40

 

A bet on ARO is a bet that the company will continue to maintain or increase its share of the consumer’s wallet. Should the economy weaken there is at least some chance that comps could accelerate. This is what happened during 2008 and 2009. The worse the economy became, the more likely parents were to push their children to buy cheaper alternatives. If this contra-cyclical event happened again it would be great, but we only need ARO to print slightly higher than low single digit comps in the back half of 2010 and 2011 for the thesis to play out.

The concept, at ~900 stores is nearing maturity. Management’s goal is for 1000 to 1100 stores. They have a new concept, p.s., aimed at tweens, but it’s too early to give them any credit for it as a growth vehicle.

The company delivered an 8% comp in Q1 of 2010 (Feb, Mar, Apr) and a 1% comp in May which is the first month of Q2. That 1% May comp came in spite of +500 bps of comp being shifted into June due to the timing of Memorial Day. Put another way, ARO delivered an 8% comp in Q1 and an adjusted 6% comp in the first month of Q2 (adjusted comp = the 1% actual comp plus the 5% shifted into June). Trends remain strong. For ARO to deliver full-year earnings in line with the Street would require comps to decelerate throughout the year to low single digits. Anything is possible, but if the economy remains stable I believe ARO is poised to outperform.

Management stresses that they are running a “promotional” specialty retailer. Low prices are the point. Yet in spite or perhaps because of this, management has increased their market share rank among 14-17 year olds as follows:

Market Share Rank, reported by NPD, taken from ARO management presentation:

                                2005                       2008                       2009

Girls                       5                              3                              1

Guys                      8                              5                              3

 

Same store sales are the key to this story. If ARO delivers upside surprises to same store sales, which is to say they simply manage to deliver mid-single digit or better comps (arguably worse than current trend), they should exceed estimates and dispel the notion that they are a retailer whose fortunes weaken during a recovery.

Overall Street and/or selected sell-side estimates are roughly as follows (January fiscal year end):

Jan year-end

2010A

2011E

2012E

Same store sales

10%

3.70%

2.00%

Revenue

2230.1

2471.5

2693.6

Net income

229.6

268.8

291.0

EBITDA

450.4

504.9

544.0

Earnings

2.27

2.83

3.06

Shares

101.0

94.9

94.9

       

Mkt Cap @ fair value

4145.1

4177.5

4177.5

Cash

347.0

513.9

782.6

EV at current price

 

3674.1

3405.4

EV/EBITDA

 

7.28

6.26

Stock price at  6.2 x jan 2012 ev/ebitda

$44.00

               

My estimation of fair value is 6.2x 2010 ev/ebitda or $44.00. That number is in line with current trading multiples for TJX and ROST. Note that this fair value is based on Street estimates. Should the thesis play out then the company should beat earnings and see additional upside at the same target multiple.

Catalyst

Trend of above street same store sales continues.
    sort by    

    Description

    Aeropostale (ARO) is specialty apparel retailer of promotionally priced (low price) teen apparel. It has delivered positive same store sales and earnings leading up to the recession, throughout the recession and has continued to do so since the economy bottomed. In spite of these solid fundamentals the stock trades at much too low ev/ebitda multiples of 5.5x trailing, 5.1x 2010 and 4.8x 2011. These multiples are on Street estimates, estimates I believe are too low. The stock trades at $30.50.

    Applying a peer 6.2x ev/ebitda multiple (current multiple for ROSS and TJX) to FY2011 (Jan 2012) Street EBITDA yields a $42.00 stock, respectively, and 46% upside over the next 12 to 18 months. Although ROST and TJX are off-price retailers of brand name over-runs and ARO is a genuine specialty retailer (designs its own clothing), I believe ARO’s promotional nature and ability to perform well in a recession make the three good comps for each other.

    In spite of consistently strong comps and return on equity that beats its peers, ARO trades at multiples associated with an out-of-fashion, poorly managed retailer than can’t deliver in the kind of economy we have now because the Street thinks that as the economy recovers parents will return to their “old normal” spending habits and will re-direct their children away from the likes of Aeropostale and send them back to Abercrombie and Fitch (ANF) where the cost of a top or jeans is 2x to 3x that of ARO. This worry is misplaced as I believe the “new normal” characterized by chronic unemployment and underemployment, underwater houses and retirement funds, and parents worried about how to pay for college is here to stay for the foreseeable future. As the Street comes to see these economic trends persist they will begin to see that ARO is part of the long term solution for parents to clothe their children at a decent price but with enough teen cool factor that the kids will wear the clothes.

    It is worth noting that the market had the same concern regarding off price retailers, Ross Stores (ROST) and TJ Maxx (TJX). The thinking was that as the economy recovers shoppers are going to rush back to paying full price at specialty retailers. However, perceptions are already beginning to change and the Street is increasingly viewing  ROST and TJX as new shopping mainstays for a wider slice of shoppers. As I have noted, I believe the same will happen for ARO.

    ARO is cheap on both absolute and relative terms, has a market cap of $2.8B, is debt free, has $313M in cash on the balance sheet and has higher returns than its peers.

    EV/EBITDA

    TTM

    2010

    2011

    ROE (%)

    ARO

    5.5

    5.1

    4.8

    57.21

    ROST

    6.2

    5.8

    5.6

    43.59

    TJX

    6.2

    5.9

    5.5

    49.71

    AEO

    4.5

    4.0

    3.6

    10.75

    ANF

    5.6

    4.7

    4.0

    5.05

    GPS

    4.0

    4.1

    3.9

    25.17

             

     


     

    ARO has delivered 13 straight years of positive comps including throughout the recession:

     

    Feb

    Mar

    Apr

    May

    Jun

    Jul

    Aug

    Sept

    Oct

    Nov

    Dec

    Jan

    2010

    7.0

    19.0

    -5.0

    1.0

                   

    2009

    11.0

    3.0

    20.0

    19.0

    12.0

    6.0

    9.0

    19.0

    3.0

    7.0

    10.0

    6.0

    2008

    7.0

    2.5

    25.0

    6.0

    12.0

    13.0

    13.0

    5.0

    1.0

    -5.0

    12.0

    11.0

    2007

    2.3

    15.9

    -14.0

    1.9

    0.2

    -11.9

    1.7

    1.3

    3.0

    6.6

    12.2

    4.7

                             
                             
                             
                             
                             
                             
                             

     

     

    ARO’s unit pricing ($ per clothing item) is lower than peers:

     

    ARO

    PSUN

    AEO

    ANF

    Hollister

    Juniors graphic tees

    10

    10

    10

    24

    16

    Juniors denim

    20

    28

    35

    60

    30

    Guys graphic tees

    10

    20

    12

    30

    10

    Guys denim

    20

    28

    35

    60

    40

     

    A bet on ARO is a bet that the company will continue to maintain or increase its share of the consumer’s wallet. Should the economy weaken there is at least some chance that comps could accelerate. This is what happened during 2008 and 2009. The worse the economy became, the more likely parents were to push their children to buy cheaper alternatives. If this contra-cyclical event happened again it would be great, but we only need ARO to print slightly higher than low single digit comps in the back half of 2010 and 2011 for the thesis to play out.

    The concept, at ~900 stores is nearing maturity. Management’s goal is for 1000 to 1100 stores. They have a new concept, p.s., aimed at tweens, but it’s too early to give them any credit for it as a growth vehicle.

    The company delivered an 8% comp in Q1 of 2010 (Feb, Mar, Apr) and a 1% comp in May which is the first month of Q2. That 1% May comp came in spite of +500 bps of comp being shifted into June due to the timing of Memorial Day. Put another way, ARO delivered an 8% comp in Q1 and an adjusted 6% comp in the first month of Q2 (adjusted comp = the 1% actual comp plus the 5% shifted into June). Trends remain strong. For ARO to deliver full-year earnings in line with the Street would require comps to decelerate throughout the year to low single digits. Anything is possible, but if the economy remains stable I believe ARO is poised to outperform.

    Management stresses that they are running a “promotional” specialty retailer. Low prices are the point. Yet in spite or perhaps because of this, management has increased their market share rank among 14-17 year olds as follows:

    Market Share Rank, reported by NPD, taken from ARO management presentation:

                                    2005                       2008                       2009

    Girls                       5                              3                              1

    Guys                      8                              5                              3

     

    Same store sales are the key to this story. If ARO delivers upside surprises to same store sales, which is to say they simply manage to deliver mid-single digit or better comps (arguably worse than current trend), they should exceed estimates and dispel the notion that they are a retailer whose fortunes weaken during a recovery.

    Overall Street and/or selected sell-side estimates are roughly as follows (January fiscal year end):

    Jan year-end

    2010A

    2011E

    2012E

    Same store sales

    10%

    3.70%

    2.00%

    Revenue

    2230.1

    2471.5

    2693.6

    Net income

    229.6

    268.8

    291.0

    EBITDA

    450.4

    504.9

    544.0

    Earnings

    2.27

    2.83

    3.06

    Shares

    101.0

    94.9

    94.9

           

    Mkt Cap @ fair value

    4145.1

    4177.5

    4177.5

    Cash

    347.0

    513.9

    782.6

    EV at current price

     

    3674.1

    3405.4

    EV/EBITDA

     

    7.28

    6.26

    Stock price at  6.2 x jan 2012 ev/ebitda

    $44.00

                   

    My estimation of fair value is 6.2x 2010 ev/ebitda or $44.00. That number is in line with current trading multiples for TJX and ROST. Note that this fair value is based on Street estimates. Should the thesis play out then the company should beat earnings and see additional upside at the same target multiple.

    Catalyst

    Trend of above street same store sales continues.

    Messages


    SubjectLove the idea, but needs some clarifications
    Entry07/02/2010 09:35 AM
    Memberbaileyb906
    I love ARO and I think it is a cheap stock and sustainable business but there is one important thing the author has missed about this idea.   The suggestion that people will switch from ARO back to AEO or ANF when the economy improves is a common worry and misperception among non-retail specialists and retail people who do everything from their desk or a midtown hotel and are never in the mall.  The customer who shopped at ANF before the recession is not at ARO, they never have been, and they never will be.  So this whole concern about ARO benefitting from trade down than will wither with the return of trade up is nonsense.  Try staying on the subway north of 125th St and you will understand the growth of ARO.  They have built a huge brand amongst the lower income demographics and in what has been called the "urban" segment.  It's not the children of white investment bankers and lawyers who have been put on a budget that has driven ARO comps through the recession.  They may have gotten some trade down benefit from AEO, but I think even that is limited.  If investors really understood where ARO's business was coming from, the whole question of lack of sustainability would die down.
    As for the use of TJX and ROST as comps, I totally disagree.  It's a totally different business model being a vertically integrated specialty retailer who designs and sources their own inventory versus being an off-price retailer.  The inventory and fashion risk at ARO and any specialty retailer is much higher than at a TJX or ROST.  Also, TJX has substantial international exposure and is also so much bigger in cap, I think that weakens its value as a comp.  You should comp ARO against the teen retail universe as well as the broader speciality retail universe.  You can also look at it on a free cash flow yield basis.  I think you will get to the same answer about fair valuation but you will get there in a way that is more defendable. 
    Also, I think ps is not insignificant.  There is such a dearth of square footage growth stories in retail and there are so few retailers with second or third concepts that have any promise that I think any traction at all at ps (which I think they will get) will be a big justification for multiple expansion.
    I love the idea and agree 100% but just thought I would add my two cents.

    SubjectRE: Love the idea, but needs some clarifications
    Entry07/07/2010 07:44 PM
    Memberbeep899
    Baily, thanks for your value-adding viewpoints on ARO, especially your insights on their biz model and target market.  In spite of the imperfect nature of using ROST/TJX as comps I still believe it is useful since they both have a signficant focus on low-price apparel. They make useful comps in my mind than the handful of specialty retailers that are doing well because most those have something unique or higher-end about them, characteristics that I don't think apply to ARO. In any case, its sounds like we're getting to roughly the same place which is good.

    Subjectgross margins
    Entry08/17/2010 08:10 PM
    Memberfinn520
    It looks like gross margins have taken a few big steps upwards in recent years, from 30-32% in 2002-2006 to 35% in 2007-2008 to 38-40% in 2009-2010.  From a quick glance at the 10-k, it appears a good chunk of that last jump was from "improved merchandise margin".  Do you think this is sustainable and do you have any idea what is behind the shift?  If you assume they go back to 35% gross margins, the stock price makes a lot more sense.  Thanks for any thoughts.
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