Investor Destination

Urban Outfitters – Worth Considering.

June 7, 2017 by InvestorDestination Team

The challenging retail environment is negatively impacting retailers. Many retailers including Urban Outfitters (NASDAQ:URBN) have reported dismal quarterly results. The company’s challenges are also enhanced by its fashion miss in some of its brands. The company expects its spring fashion miss to negatively impact its second-quarter results. So, investors are pessimistic about this company, and its stock price has fallen and hit our entry point for the company.

Overview

URBN is a specialty retail company that offers quality products. It has strong, unique brands such as Urban Outfitters, Anthropologies, Free People Terrain and Bhldn. Its brands cater to a unique lifestyle. Its stores are not just another retail store in the mall; they have a unique look and feel. For each brand, the company has a well-defined value proposition and tries to deliver on that. When the company doesn’t meet its expectations, the management takes accountability and doesn’t blame the weather or a weak retail environment.

Urban Outfitters brand offers fashion apparel and accessories for men and women of age 18 – 28. This brand has an origin in ‘hipster’ culture, and its stores have dark, wooded, vintage look and feel. Its Free People brand caters for younger, brighter, gypsy chic. The Company's Anthropologie Group consists of the Anthropologie, Bhldn and Terrain brands. Anthropologie brand’s ideal demographic is affluent, settled-down career women in their 30s and 40s. It has a variety of product categories such as apparel, accessories, home furniture, decor, beauty, etc. As it is selling a lifestyle to its customers, its stores are large and have a unique store environment which is created through special selection of music, unique products from around the globe and aromatic candles.

Current industry situation

In general, the retail industry is impacted by consumer spending which is influenced by macroeconomic environment and unemployment rate. For the last few years, despite low unemployment rate, the mall traffic is on the decline and the retail environment has been very promotional and challenging. This can be blamed on consumers desire to shop whenever and wherever. So retailers are adapting to this shift in consumers shopping habits and building omnichannel. The promotional environment is impacting sales and margins negatively. Supporting omnichannel is further cutting into retailers’ margins, and investors seem to be worried about it.

The upheaval won’t affect all players equally; there will be success stories and failures. During an industry transformation, the success of a company depends on its ability to transform and evolve. The disruption creates uncertainties, and the journey is a bumpy ride.

	2008	2009	2010	2011	2012	2013	2014	2015	2016
Revenue (in millions)	1,582	1,713	1,905	2,196	2,581	2,586	2,675	2,661	2,476
EPS	(0.11)	0.39	0.65	0.83	1.10	0.42	0.43	0.01	0.70
Revenue Growth	(7.7%)	8.3%	11.2%	15.2%	17.5%	0.2%	3.5%	(0.5%)	(7%)
Operating Margin	(2.5%)	6.3%	9.3%	10.1%	11.1%	5.5%	4.4%	(0.5%)%	5.7%
Debt to Asset	0%	0%	0%	0%	0%	0%	0%	0%	8%
FCF % Sale	(0.33%)	8.61%	8.74%	5.62%	7.89%	3.80%	6.08%	4.42%	7.38%

Why to invest during these uncertainties?

Industry challenges also create some bargain opportunities. Now the question is whether URBN is undervalued or a value trap. It depends on whether the current situation is short-term or it is the beginning of an end.

To be a successful omnichannel retailer, URBN needs to maintain a consistent brand image across different channels and use appropriate means to acquire customers. It has invested in technology to build its online presence. It is using social media, email and online advertising to strengthen its online presence and build an emotional connection with customers. It is trying to personalize the online shopping experience. It has a strong social media presence. For example, Urban Outfitters brand which targets 18- 25 years men and women has more than 7M Instagram followers. A few years ago the company set a goal to generate 50% of its revenue from online. The company already generates 50% of its Free People brand revenue from direct business and around 35% of Urban Outfitters and Anthropologie sales from the direct business. So, it has a relatively strong online business, and the company is planning to double its online revenue within next five years. However, the omnichannel efforts have negatively impacted its margins. The company is trying to improve efficiency, reduce occupancy costs, but it may be tough to achieve the past level margins. At least the company is realistic and doesn’t promise that to shareholders.

Many retailers have expanded store base aggressively, and now they are closing doors. URBN has always taken a very conservative, disciplined approach to expanding its store base. So, while the company is investing in omnichannel, it is not frantically closing stores. However, periodically closing few underperforming stores is part of doing business. The company's disciplined approach to open new stores also boosts management’s credibility regarding its goal to double online revenue within the next five years.

While retailers are embracing online shopping as a complimentary to their business, they are always looking for different ways to attract consumers to their stores. Initially, they were offering features such as order online, pick up at stores to increase store traffic. Now, even though online shopping and social media are on the rise, millennials are valuing experiences. So, retailers are looking for more innovative approaches to attract consumers to their stores and provide enhanced store experiences. For example, American Eagle Outfitters opened a new Aerie store in New York which offers yoga classes, and according to the company, that store is performing very well. To improve customer shopping experience, URBN acquired a small, family-owned pizza company last year. The company is experimenting with an idea of turning its stores into a place to hang-out as well as eat and shop. While its pizza stores have good customer reviews, it is yet to be seen whether it will be a success. However, the company’s conservative management is not going to expand rapidly and end up in a situation where it needs to close many stores. While it is hard to predict if and when the margins will improve, it is a well-managed company with diversified brands and is evolving with the industry.

Conclusion

URBN is a well-managed company with no debt and a strong balance sheet. It has consistently grown, generates strong free cash flow and periodically repurchases shares.

While the way consumers shop is transforming, their need for apparel, beauty, home products, furniture, etc. are not vanishing. URBN is evolving with the industry. Currently, the company is also facing challenges due to Anthropologie apparel fashion miss. However, fashion hit and miss are part of doing business. Creativity and disciplined approaches are its strength, and the company still possesses them. In our opinion, URBN still possesses a competitive advantage and has good long-term prospects.