You know how we've been told for months now that rising cotton prices were going to eat into clothing retailers' bottom lines? Well, that time has arrived, and countless retailers were strung up like pieces of meat in a freezer, taking a beating from Rocky Balboa in after-hours trading last night.
It wasn't just Aeropostale (NYSE: ARO) that warned of a miserable quarter ahead, but rivals Gap (NYSE: GPS), Wet Seal (Nasdaq: WTSLA), and Zumiez (Nasdaq: ZUMZ) all offered forecasts that either fell a mile short of, or were at the very low end of current second-quarter projections. And most, if not all, blamed rising cotton prices as one reason their profit projections are tumbling. But for our sake let's focus on Aeropostale, which has gone from a "retail belle" into a "runaway sell" in just a matter of months. Is it time to walk away from this struggling retailer or is the value here just too compelling?
Blindly throwing darts
For the quarter, Aeropostale met reduced profit expectations of $0.20, but fell mildly short on revenue, reporting $469.2 million versus the $477.8 million consensus. Where the wheels really fell off the wagon was in the company's second-quarter guidance. Aeropostale guided profit projections to $0.11 to $0.16 versus a consensus figure of $0.27 -- yikes!
But there was no finger-pointing at Aeropostale. The company could have blamed rising cotton prices and left it at that, but put the blame instead on the company's poor product mix. It's tough to admit when you don't have the right product, and given the declining margins and rising inventory levels at Aeropostale, it's clear that something needs to change. Change doesn't come overnight, however, and it will likely be months before Aeropostale is able to clear out the majority of its unwanted inventory, even at large discounts.
The company is also competing in a market where brand loyalty is low, aside from a company like Abercrombie & Fitch (NYSE: ANF), which, not surprisingly, was one of the few retailers to have a good quarter. With consumers on the lookout for the best deals, they will gladly jump ship from Aeropostale to a competitor if the price and/or product are right. Which brings me to my next point ...
Is Aeropostale doing everything it can to maximize its potential online? The company reported 18% revenue growth in its e-commerce business segment, but this segment currently makes up just a fraction of its revenue stream. Thrifty shoppers are doing their homework online now more than ever, and Aeropostale appears to be slow to the game in differentiating itself online from the competition.
Caveat emptor
If Aeropostale is going to be successful, it's going to need to be able to pass along price increases to consumers, differentiate its brand, and control its inventory levels. Clearly, the company is months away from having the right answers to these questions. So despite the company trading at a single-digit P/E ratio, I'd advise passing at these levels.
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