|Shares Out. (in M):||81||P/E||14.0x||0.0x|
|Market Cap (in $M):||1,131||P/FCF||10.0x||0.0x|
|Net Debt (in $M):||0||EBIT||0||0|
ARO is a specialty retailer targeting 14-17 year-olds and owns ~1,070 stores mainly in the US and Canada and has been researched in previous posts. After missing its earnings call during Q2, stock dropped from ~$20/s level and is currently trading at $13/s. Recent stock underperformance was as a result of a few industry and company specific issues:
1) Starting in the fall of 2011 and continuing to early 2012, a significant inventory glut had built up in the specialty retail channel (i.e. inventory per square foot across the industry was up ~30%-40% in Q1/Q2 of 2012). Given soft consumer demand and increase in inventory, competitors became aggressively promotional and started slashing prices to clear this excess inventory. Given competitive landscape, ARO was forced to also reduce prices, which significantly impacted same store sales. Between 2000 and 2010, average sales/sqft grew at a CAGR of 4% from ~$415 in 2000 to $625 in 2010. In 2011, sales/sqft dropped by ~10% to ~$560 as the company posted its first negative annual comp in 15 years of positive comps.
2) A second issue affecting sales was company induced. ARO failed to refresh its product line and allowed its “basic” product line to become stale along with a low penetration across its fashion line of products. Given its high reliance on basic products which resulted in little differentiation against competitors’ products, ARO had price as the only differentiating factor to compete in consumers’ eyes.
3) Another headwind has been high commodity prices, especially the rise in cotton prices in 2011. Gross margins have fallen from around 38% in 2009 to 26% in 2011. This again is due to higher raw material costs as well as higher markdowns to clear inventory.
At $13/s, the stock offers a compelling opportunity given the following factors:
1) Attractive valuations. At $13/s, company has a $1.1bn market cap, $170MM of cash on hand, and is trading at 10x FCF.
2) Share buybacks. ARO has demonstrated a shareholder friendly management with total shares outstanding decreasing from 110MM in 2008 to current levels of ~80MM. Management has stated that it would like ~$200-250MM of cash on hand to work through their working capital cycle. Thus assuming FCF generation of ~$100MM per year and given their current cash on hand, I would expect management to increase its current buyback program in mid 2013/early 2014.
3) Restructuring in product lines will lead to increase in SSS. Management has acknowledged that it dropped the ball in terms of their product line refresh, with its fashion penetration estimated at ~30%, which is too low in their mind. As such, they have started taking corrective actions to increase the penetration of their fashion lines and decrease reliance of basic lines. The fashion category tends to have less pricing pressure and tends to lead to higher AURs and higher inventory turnover, which should be beneficial to the topline and margins as they implement the strategy.
4) Another positive is that inventories in the channel have become leaner in Q3, thus reducing the markdown pressure across the industry. As stated in ANF’s Q3 call, inventories at cost declined by 21% YoY, which is significantly higher than what management had projected.
5) Cotton prices presents a tailwind for the industry as current cotton prices are at a 2-yr low which will translate into lower average unit cost pressures. During Q2, gross margins increased by ~260bps, driven primarily by higher merchandise margin and management has indicated that they expect to achieve similar gross margin expansion for the second half of the year.
Despite the recent headwinds in the company and industry, ARO still represents a compelling opportunity given its business fundamentals. While I don’t believe company will reach its historical high levels of sales/sqft or margins, I do believe the current levels represent the bottoming out and expect to see some margin recapture opportunity. My expectation is that they can grow sales/sqft back to $630 and increase margins to 29% + share buyback benefit, upside potential is 30%+.
|Entry||11/25/2012 08:45 PM|
A couple questions:
1) On the fashion product, do you have any sense for how much better it is actually selling? What exactly is the new fashion product?
2) On returing cash to shareholders, why are they so unaggressive at present and what gives you confidence they will buyback stock by next June? They have $250mm in working capital, approx $900MM a year in total product costs. $250MM seems an awfully big cushion to really need, unless mgmt is worried.
3) What gives you confidence in same store sales turing around? Stock isn't going up without those turning and they have been negative for 2 years now....
Besides that, it's certainly a cheap stock if they get margins up.
|Subject||RE: updated thoughts?|
|Entry||08/27/2013 02:03 PM|
there's a price for everything... but it's hard to support mall based real estate with $5 t-shirts
|Subject||RE: RE: updated thoughts?|
|Entry||09/10/2013 10:48 AM|
I have been slow in writing more b/c i have been hoping to do some non NYC site visits, but I haven't been able to and don't think i will in the immediate future so I'll just put a few thoughts in here.
Historically ARO has been very heavy on the "logo" merchandise, which is somewhat odd to me. After all, advertising the label that you are wearing only really works if there is an air of exclusivity or aspiration tied to the brand. As CNM3d and Nails pointed out, ARO is NOT an aspirational brand... at least not on the surface.
"Aspirational branding" is all relative after all, and if one is used to buying clothes at WMT or the likes, ARO by comparison is likely a significant step up for you.
I am thinking of ARO as being somewhere in the middle of WMT and AEO / ANF etc. The problem for ARO of course is that the WMT shoppers of the world are now able to aspire to wearing AEO and ANF as well b/c AEO and ANF have discounted to the point where their prices are also within the grasp of the WMT shopper.
The result for ARO is that they are losing the lower end shopper.
At the same time, the upper end shopper who is more comfortable with the AEO/ANF (traditional) price point but maybe went to ARO to save a few bucks on basics is able to buy those basics at AEO/ANF for less then they could historically.
The key takeaway is that ARO is losing out from the bottom and the top.
Importantly, ARO seems to realize these dynamics and seems to be reacting appropriately.
If they are losing the lower end aspirational shopper anyway, it seems to me that the right move is to try to bring the higher end shopper into the stores, which the company is attempting to do in 2 ways.
First, they are reducing the amount of "logo" (and $5 t shirts) which does not appeal to the higher end shopper and increasing the amount of "fashion" in an effort to attract the higher end customer to buying non basics. As long ago as the Q4'12 conference call management indicated that this was the direction that they were going in, and they said that these changes would start to be apparent around back to school, which we are in now.
Second, they are revamping their store design. Traditionally ARO was a more "mom friendly" store, while the new stores are set to be more along the lines of the "club" experience with the music etc etc that ANF has traditionally employed, which in theory should attract the higher end shopper a bit. This transition is just getting started and has not had any real effect yet.
The next question to think about is if the $5 t shirts and lower price points in recent years has permanently impaired the brand. Given that their target audience is really 14-17 year olds, i think there is ample opportunity here to rebrand themselves. Its not black and white, but in theory after 3 years their entire target audience has cycled through.
Of course what really matters is margins, and I think there are a few things worth pointing out that could easily lead to higher margins in the future.
First, the company sees the opportunity to close 100 stores in the next few years which "represents the overwhelming majority of stores that lose money." These stores are mostly in C mall locations.
2nd, I know nothing about fashion except that it changes. In recent quarters the company has seen strong trend in woven tops and bottoms. Wovens are typically lower gross margin items, and when woven cycles out and something new cycles in, margins should improve.
3rd, just taking a quick look at SG&A on a per store and per square foot basis vs ANF (which i realize is best of breed), it seems like the company can trim some fat here fairly easily. I am not a retail specialist so please correct me if i am wrong, but common sense suggests that a fashion follower (ARO $489k/store in SG&A) should not have higher expenses than a fashion leader (ANF $451k/store in SG&A). Also note that the spread is wider than it appears because ARO includes costs for design and merchandising in COGS while ANF includes costs for design and merchandising in SG&A).
4th, if you believe management, their high margin international licensing business should be worth .21/share in 3 years.
5th, the P.S. brand currently has 124 locations, up from 100 at the end of Q4’13. The company had indicated that 100 stores was the breakeven level, so P.S. should in theory start showing up in the bottom line… assuming they can execute of course.
So… what does all this mean? Maybe nothing. But this company is absolutely HATED right now, and I think that maybe it shouldn’t be. Yes, they have to execute, but it seems like management is aware of the problems they are facing in a difficult environment and are making the right moves to position themselves for a return to past margins.
Mind you I am not rushing out to buy this with both hands – especially b/c most of the page 1 holders have bought in the last Q or 2 making this a prime candidate for tax loss selling in a year when there are not a lot of names that have tanked – but I do think there is more here that is worth discussing...
Anyone else have any thoughts? BaileyB I’d be especially interested in your thoughts.