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Aeropostale Flies Higher than American Eagle

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Driving sales through promotions isn't the best strategy. But there's a difference here.

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The recent rally in the retail sector has turned me quite bearish on retail stocks. Retailers struggling to survive have been posting extraordinary gains over the past few months -- gains that I don't think are sustainable, given the overall retail and consumer-spending outlook. However, Aeropostale (ARO) seems to be an anomaly. While the teen retailer has, like many of its peers, skyrocketed 145% so far this year, its stock performance is actually aligned with its operational performance.

At a time when competitors are posting double-digit sales declines, Aeropostale is growing its top line by double-digit figures. For the second quarter, sales rose 20% and comps rose 12%. And while most retailers are contracting margins from massive promotional activity, Aeropostale actually grew its operating margin by 480 basis points.

The stellar performance is, of course, partly due to the "trading down" shift that's taking place among consumers right now. However, I do think that management has done a great job of studying and understanding its customer. The ability to grow a gross margin during a recession is impressive and it displays the company's ability to offer the right clothes at the right price.

If you have followed my past retail articles, you're probably wondering why I'm praising a company that's thriving on its ability to offer discount prices -- I've criticized many retailers in the past for implementing heavy promotional activity to drive sales during the downturn.

The difference between Aeropostale and its rivals like American Eagle (AEO), is that Aeropostale is already known as a "promotional" store. Consumers already go to the store with the mindset of purchasing fashionable attire at discount prices. Shoppers don't walk into an Aeropostale thinking they're going to purchase a high-end product. Thus, its brand won't be tarnished by any bargain-pricing that takes place during the downturn.

With no debt and lots of cash on the books, Aeropostale is a financially healthy. Overall, I think it's positioned to emerge as an even stronger brand as we come out of this recession -- particularly if the recent shift of consumer spending continues in its current direction. Aeropostale stands to benefit from the "new economy," as, the shift towards fiscal responsibility is forcing many teens to trade in their expensive Abercrombie (ANF) tees, jeans, and hoodies for Aeropostale's near-exact attire for half of the price.

Among the top teen retail brands, Aeropostale is far more attractive than its competitors, like Abercrombie & Fitch and Gap (GPS). After the 10% surge on Friday, however, I'd wait for the euphoria to settle and the stock to pull back some.

Reviewing the competitive landscape, I think Aeropostale is a solid investment right now; I believe it will remain a popular shopping destination as consumers continue to trudge through this recession.
Position in ARO
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