Aeropostale Crashed on Earnings! Is It Still a Good Investment?

Last Wednesday was a terrible day for shareholders of Aeropostale (NYSE: ARO  ) . Shares of the $734.6 million retailer fell 3.9% ahead of earnings, followed by an additional 5.98% after hours when the company reported results that fell short of expectations. With such a substantial decline in the face of deteriorating results, is it possible that some value exists for shareholders or is the company now too far down the drain for any long-term gains to be realized without the assumption of significant risk?

What Mr. Market wanted and what Aeropostale could deliver
For the quarter, Mr. Market had fairly low expectations for Aeropostale. On a revenue basis, the company was expected to report $520 million. Though such a large take for such a small company sounds impressive, the estimated revenue would have represented a 14.2% drop from the $605.9 million the company reported for the same period last year.

Unfortunately for shareholders and management alike, revenue came in at $514.6 million, 1% below estimates. This came in spite of a 3% increase in the number of stores over the past year to a total of 1,124. Though the number of stores likely cushioned the revenue decline a bit, the challenging environment has left management with some hard choices. In the fourth quarter, the company will open 11 new stores and remodel 26 existing ones while closing between 40 and 50 locations. Another contributor to lackluster revenue was the 15% drop in comparable-store sales that Aeropostale saw this quarter compared to the same quarter a year ago.

From a net income perspective, the situation was even worse. While Aeropostale reported net income of $24.95 million during the third quarter last year, it reported a loss of $25.62 million this year. This resulted in earnings coming in at -$0.33 per share, which fell short of the EPS of -$0.24 that analysts expected.

The primary driver behind the decline was a significant increase in the company's costs as a percentage of revenue. Its cost of sales rose from 72.1% to 82.9% of sales, while its selling, general, and administrative expenses increased from 20.9% to 25.1% of sales.

How does Aeropostale stack up against Gap and Abercrombie & Fitch?
The disappointing results reported by Aeropostale bring into question whether the company has what it takes to face rivals like Gap (NYSE: GPS  ) and Abercrombie & Fitch (NYSE: ANF  ) . Both companies surpassed analyst estimates for the quarter and they show relative strength in an industry in which most players are being hit hard.

Gap, for instance, saw its revenue rise by 3.1% from $3.86 billion last year to $3.98 billion this year. The higher revenue, combined with the company's ability to put downward pressure on costs, resulted in earnings per share of $0.72 for the quarter. This represented a 14.3% increase from the $0.63 the company reported the same year ago, and beat analyst expectations by a penny.

Abercrombie & Fitch also beat analyst expectations for the quarter, but ultimately fell short of where it stood last year. Revenue at the retailer declined by 11.7% from $1.17 billion to $1.03 billion. The significant decrease in revenue, as in the case of Aeropostale, came from a decline in comparable-store sales which fell by 14% year-over-year. The drop in revenue put downward pressure on the company's bottom line, which resulted in earnings per share (non-GAAP) of $0.52. This beat analyst expectations of $0.45, signaling that perhaps the business is better off than what Mr. Market might think.

Foolish takeaway
As we can see, Aeropostale performed quite poorly this past quarter. This is especially true when you place the company next to competitors like Gap and Abercrombie & Fitch. Moving forward, it will be interesting to see how the company's restructuring efforts are progressing and whether or not it can catch up to its peers. More likely than not, the first target the company should aim for is Abercrombie & Fitch. Business, while better than expected, is deteriorating at the retailer but at least it surprised analysts.

In the event that Aeropostale's management can pull something like this off, then the real hurdle to overcome will be Gap. Unlike the vast majority of players in the retail industry, Gap is one of the few that is growing at a reasonable clip. If Aeropostale can achieve such a successful turnaround, then shareholders will be handsomely rewarded but any failure to do so will leave them holding the bag while investors in Gap will be laughing all the way to the bank.

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