) is a specialty retailer that sells casual apparel and accessories
targeted toward teens and young adults. Aeropostale's stock has
fallen from highs of around $30 during the middle of 2010 to about
$18 in July 2011. The stocks of many of Aerospostale's
Abercrombie & Fitch
) and Urban Outfitters (
), have also declined in large part due to rapid increases in
cotton prices that have compressed margins.
Our price estimate of $36.55 for Aeropostale is about double the
market price. We believe that two key drivers of
Aeropostale's stock and our views on those drivers explain why our
price estimate is so much higher than the market price. Below
we highlight these drivers in detail.
1. Aeropostale's Revenue per Square Foot Expected
Revenue per square foot is an important metric to judge the
performance of an apparel company. As you can see from the
chart below, Aeropostale's revenue per square foot has increased
significantly during the recessionary period, even while the
revenue per square foot of some competitors declined.
Aerospostale's pricing and marketing during the recession helped
the company outperform competition and grow revenue per square
foot. We expect Aeropostale's revenue per square foot to
continue to increase as the company continues to benefit from the
brand awareness built during the recession.
If, however, Aeropostale's revenue per square foot were to
decline back to pre-recession levels of about $545 per square foot,
then that would translate to a $4-5 negative impact to the current
Trefis price estimate for the stock.
2. Aeropostale's EBITDA Margins Expected to Recover
from High Cotton Prices
Rising cotton prices have have been one of the most significant
reasons for the downward slide in the stocks of many apparel
companies. The impact has been particularly pronounced among
those apparel retailers that serve customers at lower price points
where the companies may be more reluctant to pass on the cost
increases to customers.
Cotton Prices. Source: Index Muni
Cotton was at $0.77 per pound at the start of 2010 and peaked at
$2.30 per pound in March 2011. A prime driver for the cotton
price increase was the drought in the Hubei province of China, a
major cotton producing area, followed by government restrictions on
exporting cotton out of India to safeguard domestic supplies and a
devastating flood in Pakistan.
Cotton is a key input material for apparel retailers like
Aeropostale and its sudden increase has led to margin compression.
Aeropostale's EBITDA margin for 2010 was about 18% in 2010
and it is expected that the profits will be lower in 2011, leading
to a further fall in the margins to around 12%.
Cotton prices have already started to fall and we believe this
trend will continue throughout most of 2011 as the normal supply of
the crop from China resumes. Moreover, even if cotton prices were
to remain high, this is an industry wide input cost that would
eventually lead to Aeropostale as well as its competitors passing
on costs to consumers. In either case, the margin compression
that is expected for 2011 and part of 2012 would be transitory.
Longer term, we believe margins will recover due to a
combination of falling cotton prices and some costs being passed on
Since our valuation for Aeropostale is based on cash flows
expected over a long term horizon, our valuation is positively
impacted by a forecast margin recovery. Investors that are
valuing the company by applying a valuation multiple to 2011 or
2012 EBITDA forecasts, figures that will be temporarily
depressed due to higher input costs, will end up with lower
valuations for the company than us.
However, if we're wrong and Aeropostale's EBITDA margins
continue to slide, there could be $8-9 of downside to our price
estimate for the stock if margins were to reach 10% over our
Summary of Downside Scenarios
Based on the downside possibilities we've highlighted above for
both Aeropostale's revenue per square foot and EBITDA margins, the
Trefis price estimate would be $22-25 if these scenarios were to
materialize. This still suggests meaningful upside to the
current market price for Aeropostale.
See our complete analysis for Aeropostale's stock