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Value Thoughts - Aeropostale, Inc.

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May 15, 2011 – Comments (15) | RELATED TICKERS: ARO

Aeropostale, Inc. (NYSE: ARO) is a primarily mall-based, specialty retailer of casual apparel and accessories, targeting 14 to 17 year-old young women and men through its Aéropostale stores and 7 to 12 year-old kids through its P.S. from Aéropostale stores.

The Aéropostale brand was established by R.H. Macy and Company, Inc., as a department store private label initiative, in the early 1980’s. Macy’s subsequently opened the first mall-based Aéropostale specialty store in 1987. Over the next decade, Macy’s, and then Federated Department Stores, Inc. (now Macy’s, Inc.), expanded Aéropostale to over 100 stores. In August 1998, Federated sold its specialty store division to Aéropostale management and Bear Stearns Merchant Banking. In May of 2002, Aéropostale management took the company public through an initial public offering and listed its common stock on the New York Stock Exchange.

The company maintains control over its proprietary brands by designing, sourcing, marketing and selling all of its own merchandise and its products can only be purchased in Aéropostale stores and online.The company operates 965 Aéropostale stores and 47 P.S. from Aéropostale stores. In addition, pursuant to a licensing agreement, one of the company's international licensees operated 10 Aéropostale stores in the United Arab Emirates. The company also recently announced a second licensing agreement which will allow the licensee to operated 25 stores in Singapore, Malaysia and Indonesia over the next five years.

Basis
Financial information presented in this report for Kraft Foods, Inc., is based on the company's most recent SEC Form 10-K filing for year ending January 31, 2011, as filed with the Securities and Exchange Commission on March 28, 2011.

Short-Term Investment Considerations
The stock closed recently at $21.57, with first Resistance at $24.43, a 13% increase from the recent close, second Resistance at $24.59, 14% increase from the recent close, and final Resistance at $31.31, a 45% increase from a recent close. First Support for the stock settled at $20.50, a 5% decline from the recent close.

Long-Term (5 Year Hold) Investment Considerations
In review of the company's latest annual financial information we note that the Current Ratio at 2.17, and the Cash Ratio at 1.23 were both what we consider investment quality. While close to where we like to see it, the Quick Ratio at 1.23 was not at what we consider investment quality levels. One very bright spot for the company was Return On Invested Capital at 94%. While down from FY10, given the very tough economic conditions retailers have faced over the past several years, we were pleased with this metric. We were also very pleased to see year over year growth in Free Cash Flow of 7%, and year over year earnings growth of 20%.

Earnings Growth Valuation
We are value investors, attempting to determine the value of an entire company based on its most recent audited financial information. As such, we simply refuse to pay for earnings growth and make no inclusion of it in our valuation estimates. However, we have come to realize that many investors focus on earnings growth, basing investment decisions on the spread between year over year earnings growth and the current PE.

In the case of Aeropostale, Inc., the company had year over year earnings growth of 22%, ending FY11 with earnings of $3.06 per share. With a current PE of 7, the spread between earnings growth and the PE is about 3, meaning that for a value investor considering earnings growth, a fair value for the stock is about $31.00, if the stock were purchased at its recent close.

Finanical Statement Valuation
Based on our review of the company's latest annual financial information we think a Reasonable Value Estimate for the company is in the $34-$35 range.

Assuming all due diligence was performed prior, we would set a Buy Target in the $20-$21 range, a First Sell Target in the $40-$41 range, and a Close Target in the $42-$43 range.

Based on our assessment of the company financial information that we reviewed, we believe a reasonable financial risk multiplier is 78. Accordingly, for the more risk averse value investor, we would set a Buy Target in the $16-$17 range.

Considering a recent close of $21.57, an estimated Merger and Acquisition payback of 4 years (assuming EBITDA remains the same), and Free Cash Flow of $2.61, we think the stock is currently undervalued, and a candidate for additional research for the Wax Ink Portfolio.

Wax

Disclaimer
We have no position in Aeropostale, Inc. and no plans to initiate a position in the next 5 business days. Additionally, we have received no compensation to write about a specific stock, sector, or theme.

15 Comments – Post Your Own

#1) On May 15, 2011 at 6:08 PM, buffalonate (94.69) wrote:

There are much better retail stocks to own.  Joseph S Bank(JOSB) Fossil(FOSL) and Rue21(RUE) are all much better investments in the longterm.  Aeropostale has 900 stores so there is not much more room for it to grow.  If you like value stocks you should be in the large banks.  Their tier 1 credit rating are improving across the board and the American Bankers Association says that loan defaults are down across all 8 categories.  The banks are still at historically low value so I think longterm it is a great industry to be invested in.  Ford and GM are also both great values right now.  The world market for automobiles will be expanding for a long time due to the emergence of the BRIC countries and other emerging economies. 

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#2) On May 16, 2011 at 5:52 AM, wax (97.38) wrote:

buffalonate;

If you would explain to me how to value a bank stock, I would seriously appreciate it.

I have several friends that are CFAs, and several that have graduate degrees in accounting, two of whom are federal bank examiners, and they all say the same thing...do not invest in bank stocks. And they have been saying this since the early 90s.

As to retailers, there may indeed be better picks than ARO, but since nobody ever shares their valuations for them, how would anyone know?

You mention JOSB, FOSL, and RUE, but what are they worth? What is that would make these investments better over the longer term?

Wax

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#3) On May 16, 2011 at 8:24 AM, buffalonate (94.69) wrote:

If you have ever read the legendary Peter Lynch's One Up on Wallstreet he was made famous by saying that the value of a stock should be p/e ratio equals growth rate.  If you look at the best run banks like PNC, FNFG, USB and MTB you will find their earnings growth rate is much higher than their p/e ratio maing them a great value. What I do know for certain is that the worst is behind us for the large banks.  There was just a story that came out yesterday stating that late payments for mortages were down for the second straight month.  The ABA says loans defaults are down across all 8 categories.  The best way to judge the health of a bank is to look at their tier 1 capital ratio.  That has been going up for banks across the board lately.  In the last 7 months the economy has gained 1.3 million jobs.  These facts point to a bullish future for banks.  If you are still nervous about the future of banks then you should invest in the 4 banks I listed above because they never lost a dime during the crisis and they made major acquisitions in the last couple of years giving them big upside.  My favorite bank is FNFG.  They have very conservative management and have doubled their bank branches in the last couple of years.  KRE is an etf that holds all of big banks stocks and will reduce your risk of being exposed to any one stock.  Bank stocks are being held down by fear and not their fundamentals.  All of the big banks are now profitable.  My best advice would be to buy the best 4 banks and if you are smart buy several of the worst performing banks because they are valued way below their historical value.  The most depressed bank stocks are KEY, STI, FITB, C, AIG, RF and HBAN.  Buy them all with the good banks I mentioned earlier and in a couple of years you will feel like a genius.  Now is a great time to buy the banks because many are at 3 month technical lows.  I loaded up on friday.  

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#4) On May 16, 2011 at 8:42 AM, buffalonate (94.69) wrote:

As for the small retail chains I mentioned earlier their growth rates are much higher than big retail chains.  The longterm earnings growth rate for a huge chains is 5% to 10% because they are so large it is hard for them to grow fast.  Peter Lynch made his Fidelity Magellan investors very rich by identifying and investing in well run small chains and letting them grow at 15% to 20% per year.  Using his principles I invested in Joseph S Bank and Buffalo Wild Wings several years ago and I am up over 140% on both of them.  Both of them are still a good investment today as their growth rate is higher than their p/e ratio.  Buffalo Wild Wings is growing earnings at 42% and has a p/e ratio of 26 which is a bargain.  Joseph S Bank has a growth rate of 21% and a p/e ratio of 18 which is a bargain.  You will never find this type of longterm growth in big retail companies because they are already full grown.  You need to find and invest in small retail chains before they get too large and then grow slowly.  I am going to write a blog on here today about all of the great small retail and restaurant chains I have identified.  You should read it.   

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#5) On May 16, 2011 at 2:02 PM, buffalonate (94.69) wrote:

Let me make my final case for the banks.  I have already established that the economy is improving and the fundamentals for the banks are improving.  Every one of the large banks was profitable last quarter.  Let me show you what the upside is for the most beaten down bank stocks. 

Citibank's price before the stock swap the other day $4.10 a share.  The historical high for them is 55.  Huntington Bank's current price is $6.60 and historical high is $25.  Sun Trust Bank's price is $27.90 and its historical high is $90.  Regions Financial's current price is $7.20 and its historical high is $40.  Fifth Third Bank's current price is $12.60 and its historical high is $45.  Keep in mind that all of these banks were profitable last quarter.  I am not saying you have to put huge amounts of money in the banks but the upside for investing in them is huge.  Good luck.

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#6) On May 16, 2011 at 7:26 PM, buffalonate (94.69) wrote:

I'm not in the mood to write a blog today but I will give you the short variety on the well run small chains.  The ones I like that are currently priced right are JOSB, RUE, ULTA, ROST, BWLD, PFCB, BJRI, LL, and FOSL.  I highly recommend all of those at their current price.  I really like TXRH, PNRA, and CMG but I haven't bought them yet because the value isn't there.  Several of these were featured in Forbes Magazine recently for growing their revenue the most over the last 4 years.  Here is the link.   http://www.forbes.com/2011/04/11/amazon-apple-chipotle-netflix-business-fastest-growing-retailers.html

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#7) On May 18, 2011 at 5:45 AM, wax (97.38) wrote:

buffalonte;

If you are looking at the spread between current prices and historical high prices when it comes to banks, I think that is extremely short-sighted.

What were the economic conditions during the historical highs? How much of those highs were tied to business expansion as a result of the housing bubble? How are the outstanding loans collateralized? What is the fair value of that collateral?

Just looking at the pricing spreads may work for most, but not for me.

As to the retailers, my position is the same. I refuse to pay for growth. I do not use it any place in my valuation work.

Again, many people rely on this, which is the only reason I include it in my posts.

The simple fact is, the companies you mentioned have grown revenue significantly over the past several years.

But growth is not about revenue, it's about earnings. And the article doesn't seem to spend much time on earnings.

Wax

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#8) On May 18, 2011 at 1:39 PM, buffalonate (94.69) wrote:

I realize that the value of bank stocks will probably not reach their historical highs again for 10 years but there is a lot of upside there.  The banks aren't allowed to do much proprietary trading with their own money anymore and their was the housing bubble so I realize 10% to 20% of their historical high value was bogus but that still leaves a lot of upside.  As Warren Buffet says when others are fearful you should be greedy.  The bank fundamentals are improving and they are profitable so I think the time is right.  It is very difficult to value the banks, especially the deeply depressed banks but I know in 2 years the economy will still be getting slowly better and the bank stocks will be much much higher than they are now.  Any time an industry or company becomes deeply unpopular it is a great time to look for a bargain.  I have recently bought Johnson and Johnson, BP, AIG, and a bunch of banks because eventually the clouds will clear and valuation will normalize. 

I assume you are a Grahm disciple that only pays for cash flow.  You can definitely make money doing that but investing in such slow growth companies bores me to tears.  I will invest in those types of companies if they have some type of moat but If it is just a commodities based type business I am not interested.  I am a Peter Lynch disciple who believes in finding well run regional businesses that have room to run and not buying them until the price is right.  Many of the successful small retail chains that I follow have cult followings due to their consistent high growth thus making it very difficult to buy them at a reasonable price.  For example, Chipotle Mexigan Grill has such a cult following that the valuation is permanently high and  I will probably never be able to buy it.  I usually just put these companies on my watchlist until their growth rate is finally higher than its p/e ratio.  Using this strategy I bought Middleby, Joseph S Bank, Buffalo Wild Wings, First Cash FInancial, Quality Systems, Rofin Sinar, and IIVI Inc several years ago.  I am up over 100% on all of them.  Most of them will not ever have a lot of free cash flow because they use it to expand.  What do you think of Methanex(MEOH) and Celanese(CE)?  I bought Methanex a while back because I like the business they are in and it had a really low PEG ratio.  Celanese has a new technology for cellulosic ethanol that they believe will do big things in the next couple of years. 

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#9) On May 18, 2011 at 5:39 PM, buffalonate (94.69) wrote:

Here is the earnings growth % for the small retail chains I was telling you about from 2006 to 2010.  JOSB 100%, BWLD235%, ULTA 900%, CMG 431%, PNRA 90%, RUE 330%, PFCB 40%, ROST 230%, TXRH 72%, LL 100%, BJRI 238%, FOSL 330%, FCFS 560%  Are you convinced yet they are good investment ideas?

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#10) On May 18, 2011 at 6:07 PM, Momentum21 (50.82) wrote:

wax - Thanks for putting ARO back on my watchlist. This one is setting up to look like HRB at the end of 2010...seems boring and might take some time to unfold but the entry point seems ideal. 

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#11) On May 19, 2011 at 5:59 AM, wax (97.38) wrote:

buffalonate;

I understand your perspective when it comes to banks, and though it may appear that I am not interested in banks, that really isn't the case.

Actually, when all of the finanicals imploded in 2008, I seriously considered cashing in everything I owned and putting it all, 100% into Bank of America stock.

In the end I didn't, and I didn't for one reason. I do not understand the banking business well enough to invest in it.

As to growth or no growth, that's a different discussion. Like most people, I bought growth in the late 90s, and like most people that turned out to be the wrong thing to do.

Today I try and determine what a reasonable value for a company is as an ongoing concern. I then take my valuation and compare that to the simplest of simple growth valuations which is the spread between the PE and year over year earnings growth.

Every worksheet I produce includes short-term valuations, long-term valuation (no earnings growth included) and an earnings growth valuation, which is just an adjustment of the current price after the spread between year over year earnings growth and the PE have been factored in.

So while I am not opposed to earnings growth, I'm cheap, and believe that I should get it for free.

As to the companies you listed the earnings growth for, they are all on my watchlist. The issue I have with most of them, is, as you noted, growth factors seem to be imbedded in all of them.

When you compare the value of the business to the value of the stock, the difference is how much an investor is paying just to own growth.

And like you, I wish I hadn't missed the boat with several of them, but I still have 2500+ stocks to choose from.

Wax

 

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#12) On May 19, 2011 at 6:01 AM, wax (97.38) wrote:

Momentum;

I'm glad I could help. And yes boring is good way to look at it. Escpecially when boring is making me money.

Wax

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#13) On May 19, 2011 at 11:35 AM, buffalonate (94.69) wrote:

You must have been drinking when you thought about putting 100% of your money into one bank.  That would have taken some serious balls.  I  could see putting 100% of your money in a bank etf like kre because it spreads your risk out and you still get the upside.  If you are still wary about the banks I think you should seriously look into First Niagara Financial Group and PNC Financial.  Both were profitable though the financial crisis which means they can survive virtually anything.  PNC bought National City which will give it huge upside over the next couple of years.  First Niagara has doubled bank branches through acquisitions in the last 2 years.  First Niagara also has a 4.6% yield which is a nice bonus. 

I think the individual investor has a huge advantage over the wallstreet guys.  They manage so much money they can't invest in the really rapid growth small and midcap companies due to securities laws.  The individual investor can invest in anything they want and as much as we want with no restrictions.  It is because of these advantages I have more than doubled the market return over the last 6 years.  Wall street invests in large cap stuff because they have to.  I don't think the individual investor should ever invest in large caps unless there is an obvious value play that can't be ignored.

   

 

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#14) On May 20, 2011 at 6:00 AM, wax (97.38) wrote:

You're right, it would have taken some serious stones.

In the end, I just kept adding to a position I had in FTO, ending with a cost basis of $12.

The company is merging with HOC and the price was fixed at the time of the announcement at $28.

So at the end of the day, the great economic/market dump of 2008/2009, is going to be very profitable for me.

Wax

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#15) On May 20, 2011 at 12:19 PM, buffalonate (94.69) wrote:

ARO is taking a beating, down 20%.  I might buy some now.  I told you there were better retailers.  In the larger retailers I would be more interested in the high end retailers like Abercrombie because they are more depressed. 

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