Aeropostale's Earnings: 3 Key Things to Watch

This week, mall-based apparel giant Aeropostale (NYSE: ARO  )  is scheduled to report its third-quarter results. Investors are hoping for some good news after Aeropostale's dreadful second quarter. Will this be the quarter that the company stops the bleeding, and finally separates itself from fellow apparel laggards like Abercrombie & Fitch (NYSE: ANF  ) and American Eagle Outfitters  (NYSE: AEO  ) ? Is the company finally ready to compete with industry leaders like Urban Outfitters (NASDAQ: URBN  ) ?

Here are three key things to watch in Aeropostale's earnings.

Can anything stop the bleeding?
Aeropostale is coming off a particularly dismal quarter, and the company needs a plan to stop the bleeding. In the second quarter Aeropostale swung to a loss of $0.34 per share, with revenue declining 6%. The only real reason that was given for the losses was that this segment of the apparel industry remained challenged, which is true, but there wasn't a real "plan" that would offer future hope.

Management has blamed increased competition, and heavy discounting, for the recent slide. Considering that inventories are now at sky-high levels, and competitor Abercrombie is slashing prices on holiday sale items by as much as 40%, does Aeropostale have a plan to finally avoid the markdowns? A plan is needed because, in retail, high inventories and "promotional sales" are the kiss of death. 

Abercrombie and American Eagle each saw their most recent quarterly earnings decline (year over year), which illustrates how severe the industry woes are. Still, some apparel retailers like Urban Outfitters grew revenue and earnings for the quarter, and American Eagle's management team gave a more hopeful outlook than Aeropostale's did. 

Aeropostale's management team issued weak guidance and alluded to additional store closings in its most recent call. CEO Thomas Johnson again blamed competition and promotional sales, saying: "Our negative outlook for the third quarter reflects the challenges of a highly promotional and competitive teen retail environment which we expect will continue." While I agree that this is all true, I'd rather see Johnson articulate a plan to differentiate itself from competitors than make excuses.

The first rule of retail is: If you can't explain why you're different, you have to charge less. We know that Aeropostale's management is tired of charging less, so they need to tell us how they plan to be different. Perhaps Urban Outfitters is doing better because they market to a broader age range than Aeropostale's 14-to-17-year-old crowd? Whatever the reason, my hope is that management gives details and real solutions for improvement.

A bad quarter will be a bad quarter, but if Aeropostale can articulate a plan to differentiate itself from peers, with a clear plan to stop the bleeding, things may look brighter going forward. 

Is Aeropostale for sale?
As Aeropostale's struggles have intensified, a slew of private equity firms and activist investors have swooped in to buy shares and urge management to consider a private sale. Private equity firm Sycamore Capital now owns 8% of the company, Hirzel owns 6%, and Crescendo Partners recently revealed a large stake and urged management to consider a sale. 

This has led management to adopt a "poison pill" plan  that would at least give shareholders a chance to review any offers and evaluate the potential benefits. We'll want to hear more about the poison pill, as well as management's views on a potential sale. While a potential buyout could be beneficial for shareholders, as it may drive shares up to a premium, it's not an investment strategy by itself. So let's listen closely to make sure that management has a plan, sale or no sale. 

Are promotional problems systemic?
One question that should be asked, given Aeropostale's recent reliance on promotional sales and discounts, is if there is a systemic problem with teen retail and apparel in general. Are apparel retailers being forced to mark down inventory to compete on price with e-tailers like eBay and Amazon

While this is a question worth asking, the answer is likely that the issues are not systemic for two reasons. 

First, Aeropostale has lagged its direct competitors in recent years. As this chart shows, EPS over the past four years has grown slower than at any of the aforementioned companies, except for Abercrombie & Fitch, which has slumped due to controversial comments by its CEO, Mike Jeffries. 

Urban Outfitters has returned 17.5% for the past five years, and its most recent quarter saw sales growth of 13%. How is it avoiding these struggles?

ARO EPS Diluted (Quarterly YoY Growth) Chart

ARO EPS Diluted (Quarterly YoY Growth) data by YCharts.

Finally, it's worth mentioning that Aeropostale's recent comparable-sales growth decline of 15%, and awful top-line number, included all e-commerce sales. That said, it's hard to blame the company's slide on what is happening around it. 

Accountability is key
Aeropostale is attempting to stage a turnaround, and investors should try to determine if it's for real.

With any "turnaround" story, accountability to you, the shareholder, is critical to success. So listen to this quarter's earnings call, and don't invest in the company unless these key factors are addressed.

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