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Aéropostale, Inc. (ARO) is primarily a mall-based operation, with nearly 1,000 stores open across the 50 states, Puerto Rico, and Canada, as well as 71 P.S. concept stores open in 20 states. The company designs and sells casual apparel and accessories mainly to 14-17 boys and girls. ARO maintains strict control over its product offerings—all designing and marketing of merchandise is done by Aéropostale, and purchases can be made at company-operated stores, as well as via www.aeropostale.com and www.ps4u.com. Additional stores have opened in the Middle East and South East Asia under various licensing agreements; other licensing agreements have been signed, and are expected to result in about 30 more store openings in Turkey over the next five years.

The market in which Aéropostale operates is highly competitive.  The company’s focus on children and teen-agers positions it in direct competition to the likes of Abercrombie & Fitch (ANF), and American Eagle (AEO). While some of its competitors have fared well of late, the past five years have been especially hard on ARO, which has had to offer tremendous deals in order to garner demand for its merchandise. The heavily promotional environment has caused profit margins to contract and seems to have prevented the company from transitioning to a more fashion-forward label, rather than a retailer of predominantly core basics. Additionally, the casual retail business is highly seasonal—sales, income, and cash flow are typically greater in the back half of the year. Back-to-school and holiday shopping are typically the busiest times for ARO, yet 2012 was largely unimpressive, and the company did not see as large a boost in the backend of the year to which it is accustomed.

Not all the signs are so bad for Aéropostale as comparable sales have actually improved in four out of the last five years. Still, though, some industry peers are providing much greater returns for shareholders.  In fact, while ARO shares are down over the past 12 months, The Gap (GPS) is up 70%, and American Eagle shares are ahead by some 35% during the same timeframe.

GAP’s recent progress is truly an amazing accomplishment, given that not so long ago, the company was in a similar position to where Aéropostale stands today. This is quite noteworthy, as the story of Gap’s success offers some proof that this segment of the consumer goods industry is one that is trending back to profitability in the wake of the 2007-to-2009 recession. Gap’s turnaround also clarifies a growing sentiment among customers in this retail segment; consumers are in fact more interested in style than most brands suspected in the past.  It appears that people are willing to spend more on fashion merchandise rather than stick to the bargains of more-basic attire. Gap’s early recognition of this trend, which it subsequently capitalized on, presents a blueprint for how to escape the promotional, “preppy-teen” retailer paradigm, and appeal to the desires of the evolving, and more-fashion forward shopper.

At this juncture, it is imperative that Aéropostale vastly improve its product offerings. Management has to focus on the right trends, e.g., manage an exemplary supply chain to keep inventories down, and finally come in at the right price point. Given that fashion items currently represent a small portion of ARO’s overall merchandise offering, there is currently a lot of pressure on the core basics category to produce results capable of keeping the company profitable. With this category being so constrained at the moment by the high-sales environment, savings will have to be passed along to customers in the next few quarters, resulting in margin contraction. ARO must expand its higher-margined fashion-merchandise offering to counter this situation.

ARO shares are currently trading near the low end of their 52-week range. Furthermore, the company has no debt, limited liabilities, and ample cash on hand to continue repurchasing shares. While the repurchases have been the most aggressive effort by management to return cash to shareholders, the future must produce tangible share price appreciation to keep investors interested. This will require Aéropostale to accelerate its response time to new fashion trends, and in many cases be the actual trend-setter.

Those investors considering a position in Aéropostale are advised to study our full-page report in The Value Line Investment Survey.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.