|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||3,291||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
|Subject||returns on capital|
|Entry||12/11/2005 10:09 PM|
|Thanks for the idea. What do you think are the returns on capital for this business once you incorporate the off-balance sheet operating leases? While the company has no debt, there is a significant off-balance sheet annual rental expense that really is very debt-like (ie. to run this business, lease payments must continue). |
|Subject||returns on capital|
|Entry||12/12/2005 08:06 AM|
These are all back of the envelope estimates. If people want I can do more exact calculations. NPV for Rent Commitments is $750M. Assets are $1,429M, of which Cash and Investments are $779M. Shareholder Equity is $1,070M. As I understand it, the accounting would go something like this:
…Leases Payable (Debt) $750M
Each year there would be Depreciation and Interest Expense instead of Rent Expense. Total Assets would go up by $750M and thus ROA would decline from 20% to 13%. Equity would still exceed Debt
But when calculating adjusted ROA, I think it makes sense to also adjust for excess Cash+Investments, which I’d estimate at $500M. Let’s assume that 2/3 of the Property is paid for upfront.
Leases Payable (Debt): $500M
Then Total Assets would go up by $250M instead of $750M and ROA would be approx 17%
Of course, either way, Enterprise Value would increase by $750M (about $6 per share)
|Subject||Re: Normalized EPS|
|Entry||12/12/2005 08:52 AM|
|Nice writeup. I considered writing AEOS up recently and almost bought it below $20 the other day. What held me back was the fact that recent EBIT margins have been around 20% compared to a historic range of 7-18%. Something to do with denim, I believe.|
I applied a mid-cycle 12% operating margin to next year's expected 2.5b revenue and got "normalized" EPS of about 1.25. AEOS trades at 17x this EPS level. That's not a bad price for a high ROI business, but not a screaming bargain when you consider the volatility. If the recent stumble is the start of the fall from the mountaintop there will be plenty of buying opportunities ahead. Should margins return to high single digits (as in '03) we could see low teens.
Of course margins may only "fall" to 15-18%, in which case EPS will hold up and the stock should do very well. Buybacks with the massive cash hoard should also provide a lot of support for the stock price. I rated the idea a 6 because I think it'll outperform the market long term. But I'm still on the sidelines hoping for the type of extreme bargain that seems to periodically appear in this space.
|Subject||Re: Normalized EPS|
|Entry||12/12/2005 09:12 AM|
Off the top of my head, I agree with your comments. It's tough to know if AEOS' recent excellent performance is just due to being lucky with denim. I tried to account partly for it by estimating their 5 year ROE. It wouldn't shock me to see it go into the teens in the next half year, but I'm not very good at calling short term bottoms. Also the estimate of flat earnings next year tries to take into account some degradation of margins.
|Entry||12/13/2005 06:08 AM|
I agree that AEOS can’t be expected to maintain its very high current margins (Op Margin>20%). 17% is probably more reasonable. For next year, I feel reasonably comfortable with a 10-11% revenue increase driven by 5-6% square footage increase in the AE chain, 4-5% increase in Same Store Sales, and 0-1% increase driven by the new Martin+Osa chain. Despite the sales increase, I think earnings will be pretty flat, because of the margin degradation. This is driven by the extra expenses associated with the new chain and some cooling in denim. AEOS is the market share leader in denim for their demographic. Denim fashion has been more sustainable than anybody really expected.
Below are comps for FY2001-2005 and Trailing Twelve Months (TTM). Pardon the formatting.
GM% , 2001 , 2002 , 2003 , 2004 , 2005 , TTM
AEOS , 39.9 , 39.9 , 37.1 , 36.5 , 46.7 , 48.6
ARO , NA , NA , 29.5 , 31.3 , 33.2 , 31.8
ANF , 41.2 , 40.9 , 41.1 , 42.0 , 45.0 , 56.3
HOTT , 40.0 , 39.0 , 38.4 , 38.5 , 35.6 , 34.8
LTD , 34.0 , 34.7 , 36.6 , 36.4 , 35.9 , 34.9
GPS , 37.1 , 29.9 , 34.0 , 37.6 , 39.2 , 38.5
, , , , , ,
, , , , , ,
OpM% , 2001 , 2002 , 2003 , 2004 , 2004 , TTM
AEOS , 13.4 , 12.1 , 9.6 , 6.9 , 19.3 , 21.5
ARO , NA , NA , 9.5 , 12.0 , 14.1 , 12.7
ANF , 20.5 , 19.9 , 19.6 , 19.4 , 17.2 , 16.8
HOTT , 13.6 , 13.1 , 12.3 , 13.4 , 9.7 , 8.2
LTD , 8.6 , 9.8 , 9.9 , 10.8 , 10.9 , 9.8
GPS , 10.4 , 2.2 , 7.0 , 11.9 , 12.8 , ?
|Entry||12/13/2005 11:07 AM|
|<4-5% increase in Same Store Sales>|
the only problem with this is history might bring us a -8% comp too and there is no way to know beforehand. Virtually all the teen retailers have been smokin' the past couple years - in unison - and other than a freak like URBN or CHS whenever this happens they always seem to fall apart too in time. After all, when AEOS started to put up those crazy comps, you knew that ANF wasn't going to be far behind. Now, sales comparisons are deadly, margins are sky-high, and comps in the past few weeks have shown real signs of slowing.
Still, you might be right (esp. since cash is so important this time around). You could have made the same sort of analysis with CLE last year (fat comps, peak margins, modest sqft growth) and passed and missed the resulting 40% gain.
|Subject||re: small comment|
|Entry||12/13/2005 02:22 PM|
|I agree that in this industry forecasting is a real crap shoot. Comps could be much higher than I am projecting or could be much lower. I think the current pricing and their strong balance sheet compensates us for that risk.|
|Entry||12/13/2005 09:52 PM|
|Excellent write up|
There has been evidence of slowing growth and narrowing margins which could indicate a fashion concept that has run its course.
As Paul118 notes the comps were amazing until this summer when there was definite signs of a crack in the foundation. SSS started taking off the summer of 2004 and were phenomenal until the summer of 2005. In Aug they declined notably along with margins and growth
The following just shows how different this year is from last year.
When growth slows and margins narrow, you wonder about merchandise that is being marked down and not moving. In- demand hot merchandise doesn't do that and until recently, AEOS remarked in their filings that they rarely marked anything down and the 10Ks discussion of marked down merchandise supported that.
(margins improved slightly last quarter)
growth is noticeably down from a year ago
Oct 05 Jul 05 Apr 05 Jan 05 Oct 04
Growth, revenue 13% 13.1% -26.1% 22.0% 21.7%
Growth, gross income 18% 2.6% -31.9% 37.4% 44.5%
Growth, EBIT 30% 0.0% -50.3% 91.4% 84.9%
Growth, net income 26% 5.1% -45.1% 73.4% 83.5%
Growth, Basic EPS 24% 4.4% -46.5% 70.9% 81.7%
Gross margin 46% 44.4% 48.9% 49.3% 48.8%
operating margin 19% 16.8% 19.3% 29.1% 19.0%
Net margin 12% 11.3% 12.2% 16.4% 11.5%
Growth, COGS 8% 23.1% -19.4% 8.2% 6.6%
Growth, SGA 11% 5.9% -7.2% 0.1% 32.0%
Even more telling is the dramatic increase in the days inventory is on the shelves and the increase in inventory levels. DIO have doubled. And while growth in inventory is better this last quarter, July was extremely bad
10/05 7/05 4/05 1/05
A/R Growth 41.0% -19.0% 3.8% -9.9%
Days Inventory 80.0 88.4 40.5 50.5
Growth in inventory 11.3% 48.2% 11.4% -32.7%
Cash Conversion Cycle 52.6 53.3 26.9 27.6
Days Payable Outstanding 33 40 17 28
The reason this is worth mentioning is the consideration that AEOS may not be a teen fashion shaper but simply the fortunate recipient of a fashion trend that coincided with their merchandise. If they are no longer a "hot" concept, then sales and margins may continue to disappoint. In which case is the current price sufficiently discounted if we have to wait for the next cycle to take off? If AEOS is not a leader and just a follower, it could take awhile. I am also wondering if Christmas might be disappointing and send the price further down.
If you look at these numbers and agree that they are having some trouble with their sales, margins and inventory, do you have any thoughts on why this is happening and if it is likely to continue? ie are they at the forefront of fashion and likely to lead the next trend or are they going to have to play catch up and adjust current inventory(get rid of it ) and invest in the next big thing? Or are they likely to coast along and sell enough distressed denim to maintain staus quo which is down from the heights of one year ago?
All of which asks the question is $21 a price that may be with us for a while? Or is it enough of a discount even with an uncertain successful concept to take the plunge?
I am impressed with the cash on hand, the share buybacks and the recent large insider purchase of stock. I think this is a good company--just can't decide whether they are meaningful to teen fashion at present
|Entry||12/13/2005 10:15 PM|
|I own shares of AEOS and: 1) don't have any idea where comparables will be next month, quarter or year,and 2) have no clue whether or not the company is missing some fashion trend or whether the company is a trend follower. Maybe I'm grossly delinquent...guilty as charged. |
Who, in honesty, knows these things with any reasonable degree of certainty?
What creates the opportunity here, in my opinion, is exactly that (income statement) uncertainty combined with what's going on from a balance sheet and capital allocation perspective. I think the upside is decent and downside is moderate. I'm also focused on a multi-year time frame.
That said, I am a little bit concerned with the entire landscape of teen retailers. Those things mentioned about the AEOS cash conversion cycle could also be said for the other guys...and that's a worry.
So good luck. We'll see how things turn out in the next year.
|Subject||Greenblatt Magic Formula|
|Entry||12/14/2005 10:25 AM|
|Excuse me for a self serving observation: AEOS has been showing up as the 3rd best pick on the Magic Formula website for stocks with a market cap of greater than $50 million. So in the universe of stocks, it’s clearly cheap without taking into account the issues discussed here about declining future margins. But as noted in the earlier comments, the formula does not take into account the capitalization of leases which would increase fixed assets and decrease the first ratio of EBIT/(Net Working Capital + Fixed Assets). And the addition of capitalized debt would negatively affect the second ratio of EBIT/EV.|
|Entry||12/14/2005 10:30 AM|
|I too saw AEOS on the website. It's important to realize that uncapitalized leases should be added to the balance sheets of virtually all companies along with off balance sheet pension costs (which AEOS doesn't have). So, lets have these caveats for all VIC writeups|
|Subject||inventory levels etc|
|Entry||12/14/2005 11:10 AM|
I see things a bit differently. Because this is a retailer, I think you really need to compare balance sheet items for Q3 05 to the prior year quarter, not sequentially. Remember that the inventory they have at end of October is for the Holiday Season.
Oct 05 Oct 04
Rev (q3) 578 480
COGS (q3) 309 246
Inv 253 205
AR 31 29
AP 104 84
Days Inv 74.71 76.04
Days AR 4.89 5.51
Days AP 30.71 31.16
Cash Cycle (Inv + AP- AR)48.89 50.40
The days calculations really should look forward to Q4 instead of backward to Q3, but if I've done the calcs correctly, it looks to me like they are in pretty decent shape compared to last year.
I agree that they are not going to have the kind of comps they have had the past two years. I think 2006 will be pretty flat, but it doesn't look to me like their inventory is exploding. David's store check of ARO and AEOS confirmed that as of a few weeks ago, AEOS was not doing fire sales, although of course things change rapidly this time of year.
Does this help?
|Subject||More on Asset Turnover|
|Entry||12/14/2005 11:37 AM|
Your clarification of Kitkat's comments were right on, but how do you explain the industrywide decline in asset turnover since the late 1990's? If you don't feel like doing the calculations, check out morningstar.com. They present the components of ROE in either a "financials" or "ratios" tab.
To the extent the players have maintained ROE's, considering the across the board reduction in financial leverage these guys have had to increase net income margins. You do this by raising prices, buying more efficiently etc.
What do you make of this? Seems to me that having that "in", high margin product was a part of the game over the past few years. I wonder whether it will be to the same extent in the coming years? In any event, these business could bear a bit more financial leverage...that can help out when the "in" products are in short supply. That leverage can be had by simply buying in stock with cash and those players with large founding shareholder ownership that are also friendly to outsiders are more likely to head down this path. AEOS shareholder friendliness score has improved over time in my opinion.
|Subject||re: asset turnover|
|Entry||12/14/2005 12:42 PM|
|"Your clarification of Kitkat's comments were right on, but how do you explain the industrywide decline in asset turnover since the late 1990's? "|
I'll certainly followup on your comments, but I doubt I'm the one to have any blinding insights on this industry over the past decade. The answer could be as simple as bad management. For much of my life I made my living improving supply chains, but for me personally, it doesn't help me make good investment decisions.
|Entry||12/14/2005 03:39 PM|
balance sheet pension costs (which AEOS doesn't have).>|
minor thing, but why? Don't you need to add an asset at the same time? I can't recall a single time in my short career where operating leases were a problem until a company hit the bankruptcy stage, and that's telegraphed by every single number on file well before the problem becomes critical. Being able to reserve space at the prime malls and strips in the country has to be worth something, right?
|Subject||Might be a dead end, but...|
|Entry||12/14/2005 07:01 PM|
|I did look at ANF and GPS and the decomposition of their ROE. Their performance in comparison generated a few hypotheses and further thought about what's going on in the industry beyond AEOS. Could rightly be of no value, but it's how my knee jerks.|
Again, I own a few shares of AEOS and like its prospects.
Sorry to hear that your training in supply chain management offers you little in terms of picking stocks. I've got a little background in the area as well and its helped me on a few things, Netflix being one. I wish I had spotted Dell, Walmart, Fedex, and Autozone (another Memphis company and beneficiary of work done in the mid 1990's at U of Memphis in cycle time reduction) early on as class acts when it comes to managing supply chain management.
Best wishes with your investment.
|Subject||re: small thing|
|Entry||12/15/2005 06:46 AM|
|see my first reply posted 12/12 for the journal entries. Yes, an asset is booked, which is why Return on Assets would go down if Leases were capitalized. It would have no effect on Equity though|
|Subject||re: supply chain|
|Entry||12/15/2005 06:50 AM|
I haven't yet had a chance to look at the Morningstar breakdown you suggested, but I did have an idea as to why industry asset turns might be declining over the years.
My guess is that it is due to a higher proportion of suppliers being located very far away (Asia instead of Dominican Republic for example), thus increasing the transit times which lessens responsiveness, increases the need for safety stock, and increases markdowns.
Partially offsetting this is the improvements in information technology, but my experiences is that these improvements are far outweighed by the outsourcing trend. Just my guess.
|Entry||12/18/2005 01:23 PM|
I did get a chance to look at the Morningstar stats on Asset Turnover for fashion clothing chains. You’re right, there does seem to be a definite trend lower since the late 1990’s. That’s pretty interesting and unexpected. I do believe that part, but not all, of the answer relates to longer transit times from their suppliers, as I mentioned in a previous post. I’d be hard pressed to prove it however. I’m wondering if some of it may be due to a survivorship bias in the unscientific sample of companies we are looking at.
|Entry||12/18/2005 02:13 PM|
|I tend to doubt that longer transit times or "survivorship bias" explains what's going on. These companies have been sourcing product from far flung places for some time. And I don't know why the survivors in this industry would, necessarily, show deteriorating performance in asset management.|
I'd look for explanations in three other areas: 1) growth in the aggregate number of stores (including outlets) requiring more inventory and fixed assets 2) a policy decision to stock individual stores more aggressively, and 3) a build up of cash balances due to recent successes. The first two, combined with the vagracies of fashion, add risk and variability to the net income relative to 10 years ago. The upshot...you increasingly need exceptionally shareholder friendly management to get paid (those who will return cash/buy stock when performance wanes...to smooth variability in net income), and companies with a lot of cash on hand are quite attractive.
|Entry||02/15/2006 10:09 AM|
|Any updates on this company? Any concerns that they are sorta stuck in the middle (eg ANF at the top and AEOS at the bottom?)|
|Entry||02/16/2006 05:00 AM|
|I haven't seen any signicant change in the story since I posted. Obviously it is not quite the value it was since it has advanced 25% since then, but I still think Fair Value is somewhere in the 30's.|
|Entry||03/01/2006 10:51 PM|
|Straight-forward idea...well presented...great performance.|
|Subject||near Fair Value|
|Entry||09/25/2006 10:11 AM|
|at $43.8, so I'm closing this out.|