Is This Stock Worth Buying?

Shas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

rue21 (NASDAQ: RUE), a specialty apparel retailer, reported 4Q12 results with sales increasing 22.4% to $269 million, compared to consensus estimates of $203 million. Same-store sales edged up 0.5% as against expectations of negative low-single digits. Further, despite the promotional environment, gross margin improved 110 basis points to 37.6%. In line with its peers, it has guided for (2)% same store sales in 1Q13. Let us compare how the company fared as against peers:

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Versus Aeropostale (NYSE: ARO)

rue21’s key competitor, teen apparel retailer Aeropostale, swung to an operating loss in 4Q12 due to higher store asset impairment charges and weaker sales during the holiday season. Same-store sales also declined 8%. Further, citing margin pressures from carryover inventory from the holiday season and a weak economic environment, it guided towards a first-quarter loss of $0.15 to $0.20 a share (as compared to analyst expectations of a profit of $0.08 per share).

The company has been facing challenges in its core business, especially its graphic T-shirt and fleece products. It has been trying to integrate more fashion in its product mix in order to attract its core target group of younger teens. Further, it also faces stiff competition from its higher-end rival, Abercrombie & Fitch, which promoted its products aggressively during the holiday season.

As against American Eagle Outfitters (NYSE: AEO)

On the other hand, its other key competitor American Eagle Outfitters reported strong 4Q12 results, with profit jumping a whopping 85%. Its sales increased 8.6%, with 4% growth in same-store sales. The company has been able to post strong 4Q results despite strong competition from rivals Abercrombie & Fitch and Aeropostale. However, in line with its peers, it has also guided for lower 1Q results with EPS of $0.16 to $0.19, behind analysts' expectations of $0.25.

What doesn’t work for rue21?

It’s a tough competition between these three apparel retailers. rue21 is much smaller in size when compared to its peers and has posted strong sales and EPS growth in the last five years. All three have a strong balance sheet with zero debt and strong cash balances.

Historically, Aeropostale has done better than rue21, but in the last two years, it has faced severe deterioration in its margins and sales as it tries to maintain its foothold among its competitors.

Comparing on the basis of historical margins, though rue21 has gross margins in line with its peers, it loses out on the operating margins. It has the lowest operating margin among the three. This means that the company spends its revenue for other uses and will have to focus on reducing the same.

Looking at the turnover ratios, rue21 has an alarming inventory turnover of 103 days. This is relatively high when compared to its peers Aeropostale’s 31 days and American Eagle Outfitter’s 58 days. This may be an indication that the company is not able to sell its inventory due to lower demand.

Further, rue21 also has aggressive expansion plans and the highest capital expenditure when compared to peers. In FY12, it opened 125 new stores, plans to open another 125 in FY13 and expects to open over 100 stores every year in the foreseeable future. It also plans to remodel 20 plus existing stores to a new format, and expects sales to pick up at least 15%.

This refresh strategy will be in addition to its existing plans of converting its remaining 100 rue21 stores into the rue21 etc! store format. Capital expenditure is expected to be $670 million for FY13, up 50% from FY12, primarily focused on its two new distribution centers. If the company is not able to rack up higher sales in FY13, its large capital expenditure may put a strain on its FY13 cash flows.

To put things in perspective, the company generated $646 million in operating cash flows in the three quarters of 2012, which were largely used for capital expenditure ($255 million), share repurchases ($334 million), and paying dividends ($94 million). It reported a $26 million decrease in its cash balance.

In comparison, Aeropostale opened only 27 stores in FY12 (net of closure) and plans to open 14 stores in FY13. Its expected FY13 capital expenditure is  $89 million, up 23% from FY12. American Eagle Outfitters plans to open 50 stores in FY13 a with capital expenditure budget of $250 million to $280 million (up from $94 million in FY12).

Conclusion

On its earnings call, the company announced various initiatives – remodeling its stores, capitalizing on the men’s business in smaller markets where there is little/no competition, rolling out larger 6,000 square foot store format in approximately 20-25 new and existing locations in select markets, and launch of its e-commerce business in FY2014.

rue21 aims to be a $2 billion, 1,700 store company in the next 5 years, and it may achieve it, given its strong expansion plans and initiatives to improve traffic in its stores. Given its better and positive outlook versus peers, it is a good short-term investment. But in the long run, one needs to keep an eye on the company’s cash flow generation, sales per store, growth in sales, and inventory levels.


Shas Dey has no position in any stocks mentioned. The Motley Fool owns shares of Aeropostale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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