Mall-based retailer Aeropostale's (NYSE:ARO) website features pouty, angst-ridden teens with perfect skin in midriff-baring shirts. Maybe that's not your thing. But even if you've conquered your youthful angst -- heck, even if you've got a few wrinkles -- the company that appeals to the teenage fashion obsession might have something for you.
The company has proven to investors that it's a workhorse with no sign of slowing down in the near future. So what is it doing to squeeze out such great results for shareholders? And the big question: Can it keep on keepin' on? Read on, and see for yourself.
In my opinion, before making any decision to purchase or sell shares of a company's stock, you have to start with the current valuation. I don't care if you want growth, bargain prices, or a mixture of both, you must start here to have a basis for your final decision.
Aeropostale is trading at 28 times earnings, which is well above the industry norm of 17. However, it's also growing faster than most of those other stores on the Galleria maps. The consensus from the nine analysts covering the company is a long-term earnings growth rate of 23.3%. This leaves us with a Fool ratio (PEG) of 1.20, which suggests that it is certainly fully priced, if not slightly ahead of itself.
Now we all know that accountants and analysts can fiddle with the numbers that comprise the PEG ratio, which might be its only downfall. So basing a valuation solely on that figure isn't smart. This is why I like to look at hard-to-manipulate numbers on the cash flow statements.
Price-to-free cash flow, one of my favorites, gives us a good picture of a company's earning power. Aeropostale weighs in at 23, just slightly higher than the industry average, which tells us how much bread and butter our investment dollars are socking away each year. I generally like to see anything below 20, but you must compare it to others in its industry to get its full benefit. When held beside another hot retailer, Chico's (NYSE:CHS) -- which is currently trading nearly 40 times FCF -- it appears there is still room for Aeropostale to grow.
Another hard-to-manipulate ratio is the price-to-sales ratio. I don't give this as much respect as cash flow, but it's worth a glance. Aeropostale's price-to-sales ratio is 2.01. When compared to the industry average of 0.92, shareholders aren't getting as much bang for their buck. So if those value seekers have stuck it out this far... sorry, no spring clearance sales here.
Some people view Aeropostale as a cheap Abercrombie (NYSE:ANF) knockoff -- I'll leave that for the people at E! to determine. If you look beyond the clothes, however, you'll see an investor's paradise that's leaving Abercrombie's shareholders in the dust.
The real story is in the company's growth prospects and management efficiency. If there were ever an award for improving operation efficiencies, these executives would get my vote. They have continuously been able to widen their operating margins, which of course flow through to the bottom line, thanks to excellent inventory management and cost control.
In 2003, management was able to increase operating margins nearly 200 basis points to a very comfortable level of 13% -- not bad when compared to the industry average of 9%. As the PGA would say about its golfers... these guys are good! Expect management to keep attacking these margins until they reach the same levels of other fast-growing competitors such as Hot Topic (NASDAQ:HOTT) and K-Swiss (NASDAQ:KSWS), whose operating margins run consistently north of 16%.
With a flow ratio of just below one, Aeropostale is a well-oiled machine that's turning over inventory fast. Couple those growing margins with a company that is growing faster than those pesky dandelions in my front yard (that's fast, believe me), and that translates into a growth formula with potentially explosive results. Aeropostale has grown revenues at an annualized rate of 36% since 2000, during a brutal downturn in the economy. As those revenues come in, it's expanding its market share nearly as fast. New store expansion has increased at a 27% annual rate during the same period. Aeropostale added 93 stores last year and plans on adding 85 to 90 more this year. Cash flow and earnings have grown year after year, and given the track record, they should continue to do so.
Aeropostale also has an excellent balance sheet, by the way. With zero debt and hoards of cash ($138.4 million at the end of January), it is in great position to handle this rapid growth. It can cover its current liabilities threefold, which will allow management to use that cash wisely in years to come.
One key factor that Tom Gardner looks for in his Hidden Gems is generous returns on equity. While not so hidden, Aeropostale has that, too. Year over year, it has produced ROEs of 25% or more. That would even raise Tom's eyebrows. This is a well-run business that is geared toward shareholders' happiness. Why? Because insiders own over 15% of the company. Shareholders should continue to see great things from this management team as well as great returns in years to come.
If good value is what you're after, go scrounge around in some "boring" industries that Wall Street has forgotten about, like manufacturing or health-care information. This is 2004. Fashion is the key for everyone's success, right? Prime-time television seems to suggest so.
You're not going to find value here, but this slick clothing retailer could give you the growth opportunities you've been looking for. As well as a new look.
Fool contributor Cam Goodwin does not own stock in any of the companies mentioned, but is considering a new look. The Motley Fool is investors writing for investors.
