Aeropostale (ARO) – Stock Analysis

Aeropostale, Inc (ARO): Buy

Key Statistics
Recent Price $ 21.89
Market Cap(million) $ 2,050.00
Enterprise Value (millions) $ 1,750.00
Shares outstanding (millions) 94.55
Average daily volume 3.7 million
52 week low $ 19.10
52 week high $ 32.24
Dividend Yield N/A
Insider ownership 0.5%
Fiscal year end Jan 30

ARO Selected Financials 2002-2010

Year 	     Sales 	    Net Inc 	   EPS 	         FCF 	        Shares 
2002	 $  304.77 	 $   11.32 	 $ 0.09 	$    (4.35)	125.77 
2003	 $  550.90 	 $   31.29 	 $ 0.24 	$    22.80 	130.38 
2004	 $  734.87 	 $   54.25 	 $ 0.41 	$    67.57 	132.33 
2005	 $  964.21 	 $   84.11 	 $ 0.65 	$    90.30 	129.40 
2006	 $1,204.35 	 $   83.95 	 $ 0.67 	$    86.10 	125.30 
2007	 $1,413.21 	 $ 106.65 	 $ 0.88 	$  132.50 	121.19 
2008	 $1,590.88 	 $ 129.20 	 $ 1.15 	$    88.78 	112.35 
2009	 $1,885.53 	 $ 149.42 	 $ 1.47 	$  119.10 	101.65 
2010	 $2,230.11 	 $ 229.46 	 $ 2.27 	$  280.56 	101.08 

Note: All numbers in $millions except for EPS

Business Summary:

“Aeropostale, Inc. operates as a mall-based specialty retailer of casual apparel and accessories. It designs, markets, and sells merchandise principally targeting 14 to 17 year-old young women and men. The company offers a collection of apparel, including graphic t-shirts, tops, bottoms, sweaters, jeans, and outerwear, as well as accessories, including sunglasses, belts, socks, and hats. It also offers casual clothing and accessories focusing on elementary school children between the ages of 7 and 12. In addition, the company sells its products through its e-commerce Website, aeropostale.com. As of March 15, 2010, it operated 895 Aeropostale stores in 49 states and Puerto Rico; 44 Aeropostale stores in Canada; and 15 P.S. from Aeropostale stores in 6 states. The company was formerly known as MSS-Delaware, Inc. and changed its name to Aeropostale, Inc. in February 2000. Aeropostale, Inc. was founded in 1987 and is headquartered in New York, New York.” – Source: Yahoo Finance

Valuation (Is it cheap?)

P/E (TTM) 8.9
P/E (5 year avg) 17.00
EV/ EBIT 4.33
EV/S 0.8
P/Tang. BV 4.5
EV / OCF 5.4
P/CF 6.4
P/FCF 7.8
EV / EBITDA 3.7
  • ARO trades at 9x TTM P/E which is a discount to market multiple of 14x TTM earnings ( as well as its historical P/E)
  • ARO sports a FCF multiple of 8x.
  • ARO is only 15% above 52 week low of $19.1

Is it good business? (high returns for business and shareholder?)

While there is lot of competition in the fashion retail space, ARO’s line up of fashion sells cheaper than that of American Eagle (AEO) and Abercrombie (ANF). In the last few years, while SSS has declined at both stores, ARO has done extremely well. Some numbers below

  • ARO average 5 year ROE: 38%, FCF growth: 11%, CROIC : 28%, shareholder equity : 11%, sales growth : 16%, earnings growth : 30%

Is Management share holder friendly?

+ Regular Share buy-back:

Shares outstanding reduced by 23% from 130 million in 2003 to 100 million in 2010.

“During the first twenty-six weeks of 2010, the Company repurchased 1.4 million shares of our common stock for $39.5 million, as compared to repurchases of 0.6 million shares for $13.5 million during the first twenty-six weeks of 2009. Program to date, we have returned $686.6 million to shareholders in the form of 44.1 million shares repurchased, at an average price of approximately $16 per share. We have approximately $163.4 million of repurchase authorization remaining as of July 31, 2010 under the $850.0 million share repurchase program.”

+ Strong balance sheet:

ARO has had net cash on balance sheet since 2003. ARO has no debt on its balance sheet and in fact has about $300 million in cash which is 15% of its market cap.

- No dividends : Unlike AEO and ANF, ARO currently does not pay a dividend.

- Low insider ownership

Can ARO grow?

  • Increase Aeropostale stores overseas. Right now all locations in US and few in Canada and Puerto Rico. Total 900 stores.
  • Only 35 P.S from Aeropostale stores.
  • Increasing online sales (Total net sales from the Company’s e-commerce business for the second quarter of fiscal 2010 increased 32% to $20.9 million, from $15.8 million in the year ago period.)

What can go wrong?

  • Fashion retail is a tough business with fickle customer tastes and preferences. A few years back AEO and ANF were the flavor of the season. ARO could suffer similar fate with mis-steps in execution.
  • Heavy discounting by competitors could hurt margins
  • Double dip recession could impact consumer discretionary spending
  • New concepts P.S targeting school kids could fail. Has lot of competition in that space too.

Summary of 2Q 2010

  • EPS grew by 21%($0.46 from $0.38)
  • Net Income grew by 13% to $43.6 million from $38.6 million
  • Sales increased by 9% to $494.7 million from $453 million.
  • SSS increased by 4% compared to increase of 12% last year
  • E-commerce sales up 32% to $20.9 million from $15.8 million.
  • Opened 8 Aeropostale stores and 14 P.S from Aeropostale stores.
  • (closed 1 Aeropostale store).
  • Spent $24 million in capex.

3Q guidance: $0.61 – $0.63 per diluted share (last year $0.61)

What expectations are priced in?

I employ a DCF valuation approach to see what expectations are priced in the stock. Assuming a 3% FCF growth for the next 10 years, a 12% discount rate and 2% terminal growth rate, I arrive at a $30 intrinsic value. That presents about a 27% margin of safety. It is worth noting that median FCF growth over multiple year periods over the last 10 years was about 6% and 11% over the last 5 years.

Sensitivity Matrix: Growth v/s Discount Rate
Discount Rates
10% 11% 12% 13% 14%
Growth Rates 0% $ 29.99 $ 28.19 $ 26.58 $ 25.13 $ 23.84
2% $ 33.03 $ 30.96 $ 29.11 $ 27.45 $ 25.97
4% $ 36.44 $ 34.06 $ 31.94 $ 30.05 $ 28.35
6% $ 40.26 $ 37.53 $ 35.11 $ 32.94 $ 31.00
8% $ 44.55 $ 41.42 $ 38.64 $ 36.17 $ 33.95

Catalysts

Everyone seems to ask for a catalyst for any stock nowadays. I like what Whitney Tilson said recently and I quote “Sometimes the cheapest situations are the ones that everyone agrees are cheap, but there’s no catalyst. We think cheapness is its own catalyst and if you can be patient, sometimes for a year or two, you’ll be rewarded.”

That said I like the fact that management is regularly buying back stock and this should help increase in EPS.

Conclusion

ARO is a good business that is profitable and growing. The management is focused on shareholder returns in the form of share buybacks. The balance sheet is excellent. Business has had good returns on equity and invested capital over the years. Best of all, the valuation of ARO is extremely attractive. I have a Buy recommendation on shares of ARO.

Disclaimer: I am long ARO at the time of publishing this report. My position may change at any time without any further updates. Please conduct your own research before considering an investment. This report is presented as a way to share my research and not as formal recommendation of investment or advice.

About Adib Motiwala

Portfolio Manager at Motiwala Capital LLC
This entry was posted in DCF, Stock analysis and tagged . Bookmark the permalink.

4 Responses to Aeropostale (ARO) – Stock Analysis

  1. Frank Anderson says:

    Good report!

  2. schn1eck7 says:

    Adib,

    I had to triple take when I saw how much the price had fallen since I read about Aero in ValueLine about a month ago. 33% fall? Crazy. I had this labeled as a “Great Business” on my blog- as you probably saw- but I figured it wouldn’t fall enough for me to be interested. In fact, I have said repeatedly to friends of mine in investing that they are my favorite retailer due to lower-priced apparel and their high returns on deployed capital (almost 200%). (I’m going to write a short article on “return on deployed capital” on my blog soon, so if it needs clarification, check it out soon). I had originally saw your recommendation and thought- no thanks, it’s overpriced (it WAS a month ago). BUT IT HAS FALLEN! I’m actually very excited now. I originally pegged it at about $1.5 B valuation- that it would be a great price there- but I may be able to pay slightly more than that if I believe in everything I read. Nice find. I will do more research now.

    In terms of your report, what is your reasoning for using (or even listing) enterprise value? I know what it is, I just don’t believe it is a good way to look at a company; it may skew your real valuation of it in your head. You may find yourself trying to justify their enterprise value- the stock market is just not THAT efficient. Why pay any attention to it? Also, why do you list so many things like P/E, EV/S, etc..? I feel as though, if anything, it makes your valuation process more complicated (and a little less direct & simplified). Perhaps you are listing it for readers who use a specific valuation method, but in general, why not just list your own? Those metrics are supposed to be used to value a company on average- if you were to diversify into a hundred companies with similar metrics, you would get good results, but with one company, who knows?

    I have an inherent problem with DCF models as well. What real hope in reality is a “terminal value”? It is an academic’s word that doesn’t really apply to reality. The percent growth & discount rates are also quite arbitrary. Yes, they work for companies like Coca-Cola where you’ll know exactly where they will be in 15 years, but there is no chance of you knowing where ARO will be- retail is just not that stable. I would stay away from DCF- you will find that the models can be a replacement for actual thought.

    I like to identify a percent return I like, such as 15% or 20%, and then determine the price I’d have to pay for their current earnings to give myself such a return. Think of it as a bond- if you get $20 million in payments each year and you paid $100 million for it, you have a 20% return. In the same way, if ARO is earning $20 million, you’d want to pay $100 million for 20%. A figure to keep in mind: long-term return of stock market is about 8%, so you want to look for much more than that (as a value investor anyway).

    Aero is earning roughly $300 million in operating cash flows (I use operating instead of free cash flow here because they are reinvesting the earnings for future growth; I use free cash flow if they are not growing). Therefore, looking for roughly a 20% return, you’d want to pay about $1.5 B (5X the cash flow; the cash flow ends up as 1/5 your price paid, or 20%). Granted, they are close to $2.2 B now, but since it is growing, you could still hit that 20% return if they continue to grow at a decent clip.

    For such a great business as Aero, I would even stoop to paying 6X (16% return) for their business if I did a heavy amount of research and saw everything I needed to see. This hits about $1.8 B- very close to current market cap. If I saw their ability to continue growing as a possibility & liked everything else, I would buy at today’s price. This will definitely be one of my next research projects.

    I agree completely on catalysts- I cannot stand the NEED for them from every investor, it is simply unnecessary unless you are trading options. Buy cheap and sit your ass on it- that’s the way I see it as well.

    I’m very impressed you’ve realized the ability of this business to generate a substantial amount of excess cash and is trading at a good price right now. I will definitely pursue this & let you know my findings.

    Sorry about the criticism on certain things- I wrote them out as I thought them; i figure you’d rather generate discussion and hear a “real response” than some open-ended flattery.

    Thanks for sharing

    Andrew

  3. adibmoti says:

    Andrew,

    Thanks for your feedback.

    1) Enterprise value I list for couple of reasons. One that is the value for the entire firm. Something that must be paid to buy outright. Its useful information and can tell me if there is more cash than debt ( if its less than market cap).

    2) I listed many metrics because its good to see a company from more than one criteria for valuation ( earnings -> used by Street, Cash flows/FCF -> I rely on this, EV/ EBITDA -> used by Private equity;)

    3) I used DCF in a reverse fashion as I indicated. I plugin growth rates and discount rate such that intrinsic price = current price. That tells me what expectations are priced into the stock and are they conservative or aggressive.

    4) The big concern about ARO is that the Operating cash flows of $300 million are its all time high. Is this a sustainable cash flow going forward, will it increase or drop drastically. If it drops then the low P/FCF number may not be high after all.

    5) For US environment, I will take 15% annual rate of return. 20% seems a bit too
    high.

    thanks for the feedback. Discussion brings more clarity

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