Sometimes in life your timing is great. Other times, it can be uncannily poor. But such is life, and such is investing. It keeps things very interesting and fun. Over the past week, I've been leisurely reading about teen retailers in general (AEO, ARO, ANF and others) as the market has done a number on their stock prices over the past few months.
I've focused in on Aeropostale (ARO) simply because it has been hit the hardest, and I wanted to try and see if there might be some value there.
As I mentioned, my reading in this space has been leisurely because for one, I had other ideas that I've been working on that I like better, and two, I didn't think I had a hard deadline. I had a post that I put together that is over a week old now... it's basically just some summary notes on the valuation and the business.
This morning, after finishing reading the last two 10-Qs and reading the most recent 10-K, I was going to post a few notes and consider taking a position. There are some risks with ARO, but the stock is cheap. I happened to check the EDGAR database just to see if any insiders have made any purchases or sales over the past few days (I like checking these once a week or so for companies I'm following)... and to my surprise and disappointment, I noticed that Sycamore Partners filed a 13-D this morning and disclosed that it took an 8% stake in ARO.
Sycamore is a private equity firm that has done some work in this space previously. They took Hot Topic private earlier this year.
I checked the pre-market trading, and it appears that ARO is going to be up significantly this morning (15% to 20%). This certainly isn't ideal, but I think it's still cheap enough to consider, just not as cheap as it was yesterday!
I decided I'll go ahead and post my initial basic notes on ARO. Everything here still applies. These are just the numbers. I finished reading through the last few 10-Qs and have a better handle on the business, and might write some more details in future posts. Maybe this 13-D jump will fade and there will be more opportunities to buy at the lower levels. This often happens after an announcement like this.
Here are some initial thoughts on Aeropostale (ARO):
- Current Price: $8.82 (update: now closer to $10 after the 13-D jump).
- Now at a five-year low, below $9, which was below the 2009 and 2011 low.
- Stock is priced at a level it hasn’t seen since 2005, when there were significantly more shares outstanding.
- Traded as high as $30 in 2010 (Schloss used to like to see when a stock had been priced significantly higher in the past; it’s not a necessary nor sufficient sign that there is value, but it does help to know the market has priced the business there previously).
- It’s hated. Even value guys don’t like it. Retailers are tough.
- No Debt.
- Adequate liquidity despite the cash burn ($100 million in cash plus access to an untapped $175 million credit).
- Buybacks-Shares have been reduced from 130 million to 80 million in last 10 years (Munger's “Cannibal”).
- 10 years of FCF ($68 million low, $231 million high-2010; $13 million TTM).
Take a look at the average yearly numbers from the last 10 years:
So if management can simply begin to revert their business back to the mean (which even after today's jump are still single digit multiples and double digit FCF yields), the stock might have some significant upside.
These multiples are of course based on 10-year history, and not the trailing 12 months. The recent year's numbers are terrible. The business is clearly struggling, but the stock has been decimated. It’s a formerly high valuation business with formerly high returns on capital. If the company can just stabilize, there is upside as the business is priced at less than 10 times the low FCF of the last 10 years. If the business even starts to revert back to historical ROC of 30% to 50% or more, there might be significant upside. Here are the returns the company has produced over the past 10 years:
This was a really good business at one time. It has consistently grown revenue:
And the valuations are close to all time lows.
I mentioned the earnings and cash flow multiples above based on the average annual earnings from the last 10 years. Take a look at the current Enterprise Value to Sales (EV/S) which is near a 10 year low:
Just from one comparable that immediately came to my mind this morning, Sycamore (the private equity firm that filed the 13-D this morning) acquired Hot Topic for around 0.7 times sales, nearly double the EV/S multiple that ARO currently has.
There are certainly risks. The business is losing money and if they don't turn the ship around soon, the cash will burn down to the point that the credit revolver will have to be tapped, and the firm's liquidity position could eventually deteriorate. Most of these investments I make are in businesses with problems, and I like to look for clean balance sheets. I think the company can turn around, but it may take time. The company has no debt, and that will give it more time than a company with a leveraged balance sheet. A ticking liquidity timebomb is not what you’d like to worry about when trying to turn a retailer around.
One other downside is that there is no asset protection. The company leases all of its space, and the only real assets it has is the inventory. And in the event of further deterioration, the likelihood of being able to sell the net tangible assets for what they are carried on the books for (roughly $3.50 per share) is slim. However, I think that the company would get purchased long before it faces a liquidation. Although it's not an extremely strong brand, my guess is that at some level a private equity buyer would become interested in the firm simply because of its name recognition and its current fleet of stores (ARO has around 1,100 stores, including 142 PS from Aeropostale stores, not to mention a small, but growing, ecommerce business).
CatalystsThe first catalyst is the fact that Aeropostale has hired some key decision makers and has put in place a new product development team. I have no idea if the team will improve ARO's operations, but oftentimes new decision makers can act as a catalyst for improvement. I think with a proper game plan, the business survives, and potentially could improve. Survival means upside from here.
The other catalyst that I mentioned above is the private buyer or some other takeout transaction. With Sycamore filing a 13-D, that catalyst may rear itself earlier than I initially expected.
Pessimism and Downside Priced In?This is a hated name. Retail investors hate it. Value investors (especially Buffett followers) often don't like retailers to begin with (it is a very difficult business). But I like situations where survival means upside. More companies survive at this level than don’t, especially with a good balance sheet. “Most turnarounds don’t turn” is a common phrase, but I haven’t seen any numbers to back that up. That might be just empirical observation on a few samples. And it very well might be true. How do you define a turnaround? At what point do "most turnarounds don't turn?" I'm not sure. But with a beaten-down stock in a tough industry that people don’t like at the moment, just a bit of improvement could mean good things.
Linda Greenblatt's Retail ExperiencesLinda Greenblatt (Joel's sister) ran a partnership that produced outstanding returns for 10 years or so ("upper 20's" annual returns according to Joel). She gave a guest lecture at Columbia where she talked about buying retailers when they looked the worst after a miss, or a series of misses. Her general point was that retailers get unduly punished by the market, due to the short-term nature of thinking about the next quarter or two. If you can look past the next few quarters and look out a few years, can you visualize a company that reverts back to its former profitability? It's an interesting way to generally think about it:
"Again the answer is that people love to beat up these things up. People love to write off retailers. Everybody’s thing with retailers is--because what is their reason for being? If another retailer fell by the wayside, who would care? When people see things on a negative trend, these things (retail stocks) just get battered. So having followed retail for as long as I have, the low end of multiples is 8xs to 10xs and the high end is 20xs time range—P/E multiples. A lot of retailers these days carry a lot of cash. So that also gives us some security to last through the bad times.
Psychologically when you are seeing month after month of negative numbers it is tough not to panic. I can tell you having lived through when a comp sales posts a negative 15% comp, not to say, maybe they are going out of business, maybe no one will go back into the store. It really is tough to take a step back and say it is a one season thing, or one year thing, but when they get it right, there is so much potential and the operating leverage is huge."
She talks about the case study of AEOS, and how it went from 5 to 30, but when it was 5, the margins were depressed, earnings were depressed, management wasn’t executing, and things looked bad. Thus the low price:
It’s easy to understand this reading through a case study, but hard to act. ARO looks bad. Margins are down, earnings are currently negative. Who needs it to survive? It might not, but the likelihood of bankruptcy is low. It has a strong cash position. It’s burned through some cash, but it has more of it if needed. The clean balance sheet that it has maintained will increase the odds that it weathers the storm.
To sum up Linda's general points about retail investing:
- Buy retail stocks when they are depressed and hated.
- Look for clean balance sheets.
- Former good returns and good margins (reversion to the mean if things improve).
I'm not sure if this is what is currently going on at Aeropostale, but it does look similar to the case study above, and I think that there is real value at the current price. I have some more detailed notes about the business from the 10-Ks and 10-Qs, as well as some thoughts on competitors and some other ideas, but will save those for another time.
Have a great week!
Disclosure: I don't currently hold shares of ARO but I am considering taking a position for myself and for clients. This may happen in the near future and without further notice. Please conduct your own due diligence on this, and any other idea I mention. This is not a recommendation and should not be considered investment advice.
About the author:
By using separate accounts, Saber offers its clients complete transparency and liquidity (the funds are held in the name of the client and cannot be accessed by the investment manager). Saber looks to partner with like-minded clients who are interested in a patient, long-term approach to investing that is rooted in the principles of value investing.
I also write at the blog www.basehitinvesting.com.
I can be reached at [email protected]