Although Aeropostale’s fourth quarter was in line with its previously announced guidance, it left analysts less than enthusiastic about the cadence of the current business, particularly since the fourth-quarter earnings per share forecast had already been cut nearly in half from the initial expectation.
The apparel business remains very competitive, yielding Aeropostale no economic moat, and there are other retailers that are in better competitive position at this time. While there is value in this business, management is having some trouble unlocking it, and analysts remain concerned that Aeropostale will get trapped in a cycle of discounting to drive traffic to locations, at least over the first half of 2013.
The final quarter of 2012 was disappointing, with total sales declining 1% to $798 million, despite square footage growth of 4% and a 3% increase from the extra week in the quarter. The same-store sales contraction of 8% more than offset both of the previously mentioned benefits due to a 6% decline in transactions and a 7% reduction in average unit retail across the store base. This led to adjusted gross margins that declined 210 basis points, to 24.0%, with lower merchandise margins costing 70 basis points and the deleveraging of occupancy and distribution costs of 140 basis points. The selling, general, and administrative ratio also fell by 70 basis points to 19.9%, attributable to the deleverage of store expenses, marketing investments and e-commerce transaction expenses.
Inventory positions shrank 9% on a retail per square foot basis, but management noted there was still some inventory hangover from holiday carryover products. While we don’t know what SKUs make up the inventory at quarter end, we know that old inventory generally has lower margins, and this is bound to weigh on the upcoming quarter. The forward outlook similarly lacked luster, as management noted macroeconomic headwinds were affecting traffic during the current quarter, encouraging additional promotional activity to clear through what remained of last season’s inventory.
This is expected to weigh on both the top line and the gross margin ratio in the first quarter, which should ultimately generate a loss of $0.15 to $0.20 per share in the period. This loss incorporates same-store sales that are down in the double-digit range, lapping flat comps in the year-ago period. Additionally, the management team highlighted that it continues to progress on the strategic initiatives it set last year, particularly to improve the business and the brand.
Aeropostale has begun to offer teens more relevant fashion, but so have their competitors. The entire apparel space is moving significantly faster than in the past, and we believe Aeropostale will have to significantly differentiate itself to gain traction in successfully achieving this goal. We do believe that the right brand and product projection and the 360 degree approach to marketing (stores, social media, online) could generate significant consumer loyalty.
Obviously having the right infrastructure to support these changes is imperative. We think we have a few more quarters until Aeropostale’s brand image could be reinvigorated, and would caution that a weak consumer experiencing delayed tax returns and the repeal of the payroll tax cut could choose to allocate their discretionary dollars elsewhere, affecting this retailer’s full potential earnings.
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