Urban Outfitters' Tough Fit

Urban Outfitters' (Nasdaq: URBN  ) fashion issues have become a two-part series, given Thursday's first-quarter earnings release, which follows on the heels of its sales report last week. Once again, the question is whether the worst is over when it comes to the retailer's recent fashion stumble.

First-quarter profit at Urban Outfitters dropped 26% to $20.3 million, or $0.12 per share, although sales increased 17% (for more on its first-quarter sales, click here). In a testament to the recent turbulent times in fashion, Urban Outfitters has been marking down slow-moving merchandise -- in fact, gross profit dropped to 35.8% from 42.2%.

As Rich Smith pointed out in yesterday's Foolish Forecast, swelling inventories have been a point of concern for Urban Outfitters. This quarter, as the company instituted markdowns to move merchandise out the door, inventories shrunk to a 24% increase on a year-over-year basis. Although that figure still outpaces sales, it's far better than last quarter's buildup. On the other hand, accounts receivable ballooned by 72%.

Chairman and CEO Richard Hayne offered up a cautionary tone in the company's conference call, and although he declined to give specific second-quarter guidance, he implied further merchandise markdowns are still possible. "In this climate it is better to lose some business due to an understock position than to go long on inventory and incur additional markdowns," he said.

If you recall, the big issue that has been dogging Urban Outfitters -- which is also the name behind the Anthropologie and Free People chains -- has been a major shift in fashion. Think '80s -- large tops and skinny bottoms are back, and apparently some customers have been slow to adopt the new looks. What Hayne described as "customer confusion" is an issue he expects to be "short-lived."

On the other hand, Hayne emphasized that the problem can't be entirely blamed on shoppers not hip enough to quickly embrace the new styles. He also admitted that there are still "holes" in Urban Outfitters' assortment. (I'd give him some points for candor right there.)

Flubbing fashion trends is a scary thing in retail investing -- of course, investors can sometimes take advantage of such short-term mistakes by getting a better price, banking on the idea that the company will trend right again. Just ask anyone who owns shares of Gap (Nasdaq: GPS  ) , which has had a protracted phase of merchandise missteps that continued into last quarter. Over the years, Abercrombie & Fitch (NYSE: ANF  ) has stumbled a few times, yet it has staged an impressive turnaround in the last year or so. The thing about Urban Outfitters -- and I'm not sure if this is comforting or disturbing -- is that it has been a strong performer even through the worst of times, like the recession, so the current weakness feels disconcerting to those of us used to amazing growth.

As a shareholder myself, I still feel confident about Urban Outfitters for the long term, judging by its strong historical performance, growth potential, and what I believe is a differentiated, smart portfolio of lifestyle brands. However, the short term may continue to be rocky for Urban Outfitters, and it will deserve a lot of vigilance -- after all, holes are for last year's jeans, not a product assortment.

Gap has been recommended by bothMotley Fool Stock AdvisorandMotley Fool Inside Value. Shop around all of our newsletter offerings by clickinghere.

Alyce Lomax owns shares of Urban Outfitters but no shares of other companies mentioned.


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