This Struggling Teen Retailer Is Running Out of Time

Shares of Aeropostale jumped after the company received some much-needed cash. However, unless it can find a way to stop the mass customer exodus from its stores, its time is running out.

Jun 2, 2014 at 5:30PM

Aeropostale

Source: Wikimedia Commons

The business of teen retailing is an extremely volatile one. Tastes among young shoppers swing back and forth. What's considered fashionable one year could be replaced by something entirely different in the following year. If you think this makes for a tough climate for doing business, you'd be exactly right.

A prime example of this is what's happening to Aeropostale (NYSE:ARO). Its shares jumped 15% on May 27, which makes it seem like the teen retailer is back in style. However, that's not what's going on. Instead, investors simply cheered the fact that the company received an injection of much-needed cash. The company received $150 million in credit financing  from private-equity firm Sycamore Partners.

However, make no mistake -- when it comes to Aeropostale, shoppers have spoken. Competitors like The Gap (NYSE:GPS) are hitting Aeropostale where it hurts. Put simply, Aeropostale isn't cool anymore, and it's unlikely it will be so again anytime soon.

Burning through cash with little to show for it
Aeropostale has posted losses for six consecutive quarters. The company is burning through cash at an alarming rate to keep itself afloat. To that end, Aeropostale lost $76 million in the first quarter as a result of a 12% decline in sales. This came after a horrible performance last year in which the company lost $141 million and closed 32 stores.

Aeropostale is rapidly shrinking, and there doesn't appear to be much the company can do about it. Since 2011, its gross margin has been cut by more than half, from 36.9% to 17.1% last year. . In addition, the company's average sales per store collapsed from $2.2 million to $1.6 million, which represents a 27% decline.

This is despite the fact that Aeropostale is spending a lot of money to try to lure customers back. Its selling, general, and administrative expenses as a percentage of sales have risen five percentage points in the last three years, from 20.8% to 25.9%.

The company burned through nearly $125 million in cash last year. Also, Aeropostale ended fiscal 2014 with just $136 million in working capital, down from $253 million three years ago.

Customers clearly aren't connecting with Aeropostale.

All the while, The Gap is growing and attracting more and more customers. Its earnings per share are up 45% over the last three years, thanks to rising sales and the benefit of aggressive share buybacks. The Gap reduced its diluted shares outstanding by 27% during this time, which created a lot of value for shareholders. Plus, The Gap has increased its dividend by 46% over the past year.

The Gap's strategy of generating healthy merchandise margins, managing expenses, and delivering excess cash to shareholders is clearly working. Future growth is likely, thanks to aggressive expansion in the emerging markets. The Gap brand debuted in Taiwan in the first quarter, and the company plans to open 30 more stores in China by the end of the year. This drives management's expectations for 6% EPS growth in fiscal 2014.

A dead cat bounce if there ever was one
In the investing world, an old adage heard when a company on the brink of collapse sees its stock price suddenly jump is that it's experiencing a 'dead cat bounce.' When it comes to Aeropostale, that's exactly what appears to be happening. Instead of a share price rise because of traction gained from a legitimate strategic turnaround, Aeropostale is being rewarded simply because an investor tossed it a life preserver.

The ensuing relief rally is just the result of the company living to see another day. The capital injection buys Aeropostale time, but with an eroding customer base and little loyalty among shoppers to rely on, there isn't much to stem the tide. Meanwhile, The Gap is consistently stealing away Aeropostale's customers and rewarding its own shareholders with gobs of cash.

In the clothing retail space, shoppers vote with their feet and their wallets. As a result, you'd be wise to steer clear of Aeropostale and go with The Gap instead.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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