Urban Outfitters Steps Up Its Game

By Will Ashworth | August 21, 2013 AAA

Retail's been an iffy proposition when it comes to second quarter earnings reports. One company doing well in this cautious retail environment is Urban Outfitters (Nasdaq:URBN), who delivered record results August 20. Investors liked what they heard lifting its stock more than 8% on the day. Trading within 4% of its 52-week and five-year high—Is now the time to buy?

Valuation
Before I delve into its successful second quarter I thought I would quickly discuss its current valuation. Its four major metrics: P/E, P/B, P/S, and P/CF are all at or below their five-year historical average. When compared with peers such as American Eagle Outfitters (NYSE:AEO) and Abercrombie & Fitch (NYSE:ANF) its valuation with the exception of price-to-earnings is very similar to both of them. When you consider that Urban Outfitters is growing revenue at a much faster rate it's clear that both Abercrombie and American Eagle are value plays while Urban Outfitters is a growth-at-a-reasonable-price stock.

SEE: 5 Must-Have Metrics For Value Investors

Second Quarter Results
It's hard not to like Urban Outfitters' Q2 results. Same-store sales increased 9% across its three brands: Free People was up 38%, Anthropologie 9% and Urban Outfitters 5%. Total sales increased 12% for the company thanks to 15 net store openings. Net sales in Free People's wholesale business increased 17% year-over-year to $43.5 million. It's a tiny piece of the company's overall business but every bit helps. Although it no longer breaks out its online sales given its move to an omni-channel focus—Best Buy (NYSE:BBY) is replicating its fulfillment-in-a-store concept—Trefis estimates that it generated $182 million in Q2 or 24% of overall revenue. It's got to have one of the strongest online businesses in all of apparel retail. Shareholders should like that a whole lot.

SEE: Analyzing Retail Stocks

Business was equally impressive on the earnings front in Q2 with net income increasing 24.6% to $76.4 million and earnings per share up 21.4% to $0.51. Margins were also very strong with gross margins increasing by 170 basis points to 39.3%, operating margins by 150 basis points to 15.7% and net income by 100 basis points to 10.1%. Historically, its highest annual operating margin is 19% in fiscal 2005. It has a long way to go to achieve this kind of profitability. However, if it keeps tacking on a percentage point or two each quarter it will be there in no time. That's important because its revenue today is about three times what it was in 2005.

Free People and Anthropologie
Anthropologie struggled in 2012 due to excess inventory. Fast forward to this year; its implemented new software that enables it to track its inventory across all of its channels resulting in better inventory control. Combine effective inventory control with a revamped product line and you had a recipe for success. Anthropologie has had to resort to very limited markdowns producing much better profits for the brand. Expect Anthropologie's revenues to exceed its Urban Outfitters brand sometime in fiscal 2013 or early 2014.

Free People is the third leg on Urban Outfitters stool. It finished the second quarter with 83 stores in the U.S. and Canada. With 21% of the company's overall store total, it's got a chance to deliver Urban Outfitters' third $1 billion brand within five years. Not many firms can brag about one—yet Urban Outfitters has two with another on the way. With a great looking website to sell its wonderful product mix, I like its chances. Of course 38% same-store sales growth doesn't hurt either.

Bottom Line
Urban Outfitters' stock dropped 18.6% on January 11, 2012, after former CEO Glen Senk resigned. At the time it looked like the company was heading for a great deal of pain. Co-founder and Chairman Richard Hayne stepped into the breach and since then its stock is up 80% in just 19 months. That's not bad considering many analysts felt Hayne was the wrong person for the job. At the time of Senk's resignation Macquarie analyst Liz Dunn said she had little confidence in Hayne getting the job done. They said the same thing about Hubert Joly at Best Buy. Both seem to be getting the last laugh.

Analysts forget that no one knows a business better than its founders. The business landscape is littered with examples of visionary founders who went away only to return with equally impressive results. Steve Jobs is a classic example. Sure, the business is much bigger than when Hayne was last CEO back in 2006. However, throughout those six years he was still President and Chairman of the Board.

In my opinion Hayne's barely skipped a beat.

If I could merge Urban Outfitters online savvy with Buckle's (NYSE:BKE) ability to make money in almost any market, I'd have the perfect retail business. As it stands, Urban Outfitters is still a pretty good company. Although its stock is close to its all-time high; you'd be buying growth at a reasonable price—and there's nothing wrong with that.

Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.

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