Aeropostale Inc. (ARO, Financial) is a mall-based specialty retailer of casual apparel and accessories for customers between the ages of 14 and 17. The company designs, markets and sells good-quality fashion and basic fasion products at relatively low prices under its namesake brand and P.S. from Aeropostale. Its products compete with those of other teen retailers such as Abercrombie&Fitch (ANF, Financial), American Eagle Outfitters (AEO, Financial), Hollister Co. (operated by ANF)Ă‚ and Old Navy, a brand owned by Gap Inc. (GPS, Financial). Aeropostale designs and sources all of its products, thus maintaining control of its proprietary brands. The firm owns 984 Aeropostale stores located in all 50 states, Puerto Rico and Canada, as well as 100 P.S. for Aeropostale locations.
Lack of Moat and Narrow Margins
Aeropostale has no economic moat. The lack of switching costs for customers and few barriers to entry, both typical of the apparel industry, are followed by a cost structure that shows no competitive advantages. Therefore, the company has little margin to roll back its prices, while maintaining profitability. This stands as a strong disadvantage given the increasing promotional environment, with peers like Abercrombie, Forever 21 Inc. (FOREVP, Financial) and H&M Hennes &Mauritz AB (HMb.ST) offering high-quality products at very low prices.
The firm’s loss of price differentiation, was followed by a strong weakening of its brand power, given the de-emphasis of logo products and a rising trend that favors accessories and technology over clothing. Consequently, Aeropostale posted drops in comps of 8% in 2011 and 2% in 2012 while revenues declined by 10% from 2010 through 2013. And gross margins flopped 1330 basis points from 38% to 24.7% over the last three years.
Attempting Recovery
To fight back the downward spiral the company expects higher margins from its e-commerce operations and is seeking for new opportunities in the international licensing arena, which offers high profits at low risk. The firm also expects to improve its inventory management in order to attain better cost efficiency. The U.S. market is saturated with Aeropostale stores; therefore, paring underperforming locations will also allow the company to offset the drop in comps and its lower merchandise margins.
On the other hand, the firm plans to expand its better-performing P.S. for Aeropostale stores. However, expanding its business internationally involves a high risk, given the low predictability of teenagers’ fashion trends and the fact that they vary hugely from one region to another. Moreover, purchasing habits among teenagers have changed in detriment to brand power. Thus, teens make purchase decisions driven by appealing price-points and fashion-right merchandise, making competition even harder.
Further Efforts Needed
Aeropostale´s strategy, however, isn’t strong enough to set the company back on track, and analysts estimate an annual decline in growth of -1.25% for the next five years compared to 12.46% for the industry median. In the same period, comps are expected to drop 4% annually, modeling a 3% decline in annual revenues. All initiatives will only counter the losses, and operating income is expected to reach profitability as far as in 2018.
Aeropostale’s return on equity is 8.50% compared to the industry average of 9.10% and its return on capital is 22.20% compared to its rivals´ 19.10% average. Earnings per share show a disappointing -42.60% decline compared to its competitors´ median of 13.50%. Investment gurus Joel Greenblatt (Trades, Portfolio) and John Hussman (Trades, Portfolio) sold out, quite in tune with my bearish feeling about Aeropostale's future.
Disclosure: Vanina Egea holds no position in any stocks mentioned.
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