Should You Bet on This Teen Retailer?

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

Aeropostale (NYSE: ARO) was lagging behind the other major specialty retailers in fashion products. Now it is back in the game with key fashion categories, which will share more shelf space with core products. While it reported negative comps and a gross margin decline in the first quarter, it expects to do better in the second half this year with better product cycles and merchandising initiatives. Its margins are still expected to remain under pressure with increased marketing efforts this year. Now, let’s discuss a few points in detail that will impact its performance.

New fashion categories and P.S. brand expansion will drive sales growth

Aeropostale's key fashion categories have seen positive trends despite negative overall comps in the last quarter. Woven Tops, Woven Bottoms and Denims have performed better with higher margin levels. These products are expected to drive sales growth in the back to school season.

The company's P.S. brand has opened 24 new stores in the last quarter and entered 8 new states. It has also increased its presence in the Middle East and it has plans to enter Mexico, the Philippines, Panama and Columbia. Aeropostale's fashion categories and its P.S. brand will help it to achieve better comps growth in the future.

Store rationalization and remodeling will increase productivity

Aeropostale has focused on store rationalization over the last few years and closed around 10% of its underperforming stores at different locations. It has closed 20 stores during the fiscal year 2012. It has planned 100 more store closures in the next few years with average 15-20 stores per year.

Aeropostale's store productivity will also increase due to store remodeling initiatives. The company has plans to remodel 30 stores in the next year or so. It will look to remodel 200-250 stores, which are in line for lease renewals in the next few years. Its store rationalization and remodeling efforts will increase its overall productivity in the long term.

Increased promotions and high inventory levels will put pressure on margins

The company has transformed its merchandise more towards fashion under its new EVP Emilia Fabricant. Aeropostale will increase its promotions across the channels and will come up with new marketing campaigns to attract customers. It has increased discounts up to 80% on clearance merchandise and will look to continue that on slow moving merchandise.

Its SG&A expense for the last quarter increased by 240 basis points year-over-year. It has also increased its inventory levels by 3% for the quarter, but sales declined by 9% year-over-year. Its extensive marketing spends and high inventory levels from the first quarter carry over will put pressure on gross margin in the future.

Peer analysis

In specialty fashion retail stores, the other two major players are American Eagle Outfitters (NYSE: AEO) and Abercrombie & Fitch (NYSE: ANF).

American Eagle has updated its order management and inventory management system to serve the orders from its online channel. Its process enhancement efforts will help it to track products. Its reduced lead time and product cycle time will enable it to perform better in the fast changing fashion retail segment. Its Aerie brand was the growth driver last quarter and it has repositioned the brand to target a broad customer base. Its investment in store growth, store remodeling and distribution centres will help it to drive sales growth.

Abercrombie & Fitch has completed its first market research study in the last quarter, and it will look to capitalize on its findings. It has focused on savings from process enhancements through cross-functional initiatives. These initiatives are supported by an outside consulting firm, but led by the internal team.

Its international stores are providing better margins and it has plans to increase its international presence this year. Its direct-to-customer channel has been a driving force for it, and it will look to enhance online sales with more online exclusive products.

 

P/S ratio

Op. margin

1 Yr. Fwd. P/E

Aeropostale

0.6

-4.53%

22.38

American Eagle Outfitters

1.32

6.74%

11.58

Abercrombie & Fitch

1.15

-1.66%

12.94

Source: Google Finance and Yahoo Finance

Aeropostale has reported operating margin of -4.53% and a forward P/E of 22.38. American Eagle Outfitters has the highest P/S ratio of 1.32 and lowest forward P/E of 11.58 among the three mentioned peers. Abercrombie & Fitch has negative operating margin of -1.66% and a forward P/E of 12.94.

Conclusion

Aeropostale is late in adding fashion to its stores, but it will look forward to a turnaround helped by its fashion categories. It has increased its P.S. brand presence in the US and globally in the first quarter. Its store rationalization and remodeling will increase store productivity in the next few years. It has increased its promotions for fashion products and slow moving merchandise. Despite all of these positives, its increased inventory levels and promotion expenses will put pressure on margins. So, I recommend investors hold on Aeropostale.

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Ash Sharma has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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