Aéropostale: Improving Trends Offer Buying Opportunité
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On 9th July, Aéropostale (NYSE: ARO) announced that it had partnered with teen film actress Chloe Grace Mortez as its new celebrity brand ambassador, emphasizing the company's elevated focus on fashion merchandise. The 15-year-old Dark Shadows star will be promoting ARO's philanthropic endeavors and highlighting Aeropostale’s new looks through social media, advertisements and appearances at company sponsored events.
Earlier in May, the company announced strong 1Q results, with EPS of $0.13 coming in line with raised guidance of $0.12-$0.13. Both top-line and margins showed meaningful sequential recovery, which we believe will continue throughout the year. ARO also faces one of the easiest SSS comparisons during Q2 and 2H, driven by a favorable sourcing environment and better inventory control year over year. Given these tailwinds the stock appears to be relatively cheap and we recommend buying.
Impact of the new brand ambassador: Chloe Grace Mortez appears to be an excellent choice for ARO's target demographic. This new celebrity brand ambassador role shows ARO's increased focus on fashion content within its merchandise selection. The company has been generating media buzz lately and has one of the largest fan bases (~7.5 million) among all retail companies on Facebook. We think the appointment of the teen celebrity brand ambassador will help carry this momentum forward and position ARO more attractively within the teen retail landscape, especially during the ongoing back-to-school season.
Easy SSS comparisons and promising Q2 outlook: ARO's business trends are beginning to improve as the fashion products that have been added to the assortment are working and the declines in the basics business are stabilizing. Moreover, average back-to-school spending this year is projected to increase 14%, according to an annual survey conducted for the National Retail Federation. Aeropostale remains focused on offering affordable and trendy styles which could prove to be a winning strategy for the back‐to‐school season.
The company posted a 2% SSS growth in Q1 after five quarters of declines. We back the company to carry this momentum forward and post even better SSS growth in Q2, since ARO faces the easiest SSS comparisons in July within the industry (as of result of -14% SSS in Q2 last year).
E-Commerce business and international expansion: In May, ARO opened its first store in Turkey. This makes a total of 17 international stores across the Middle East, Singapore and now Turkey on top of around 60 stores in major malls across Canada. ARO also signed a deal to open 10 to 15 stores in the Philippines over the next five years, with the first store slated to open in early 2013. Moreover, the company continues to experience strong momentum in the e-commerce business, with a 32% year over year revenue increase in Q1. Going forward, we expect strong results.
Leaner inventory: After significant inventory growth in the last two years, the company has pulled back on inventory to some extent; inventory is down 2% per square foot as of May. We expect the company to align its inventory growth with its sales growth (~9% expected) in 2012. This will result in a solid free cash flow and ARO could start buying back share in the second half of the year.
Improving margins and low valuation: ARO’s product costs are expected to decline low single digits in Q2 and mid-single digits in H2. Thus, ARO is likely to experience significant gross margin improvement starting in Q2, especially combined with potential AUR improvements.
Aeropostale is currently well positioned with respect to sales relative to its peers. What makes ARO stocks even more attractive is a low price/sales ratio of 0.67, which is the lowest among its competitors, including American Eagle Outfitters (NYSE: AEO), Gap Inc (NYSE: GPS), and Abercrombie & Fitch (NYSE: ANF). AEO has the highest price/sales of 1.21, followed by Gap (P/S=.96) and ANF (P/S=.68). So even with conservative sales growth estimates, Aeropostale is likely to experience price appreciation from an improved operating margin. Thus, we recommend buying ARO.
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