One of the most interesting transitions in the apparel industry is that these days shoppers aim to look different when it comes to apparel and accessories, versus the previous notion of blending in.
As a result of this trend, we've seen the likes of American Eagle (NYSE: AEO ) and Abercrombie & Fitch (NYSE: ANF ) fall from grace, and they have fallen hard. The "lifestyle" brands have managed to swoop in and gain market share from these retailers. Urban Outfitters (NASDAQ: URBN ) has been one of the biggest benefactors; the retailer is up over 50% over the last two years.
Urban considers itself to be a "lifestyle" apparel company, operating the Urban Outfitters, Anthropologie and Free People brands. The company operates across the age spectrum: the Urban Outfitters brand targets 18-28 year olds, Anthropologie targets 28-45 year olds, and Free People targets 25-30 year olds.
Lifestyle versus teen retailers
The major teen retailers, which include American Eagle and Abercrombie, have been suffering because of companies such as Urban Outfitters and Forever 21. Again, this comes as there has been a shift in shopper preferences. A few years ago everyone wanted to look alike, hence the popularity of Abercrombie, American Eagle and Aeropostale. Now, looking different is the new style. That means lifestyle brands like Urban Outfitters are in full flavor.
Both Abercrombie and American Eagle trade at what appears to be a cheap 12.5 P/E, but they could be value traps. If these two teen retailers cannot gain traction by adapting to new trends, they could see even more downside; both are down over 25% year to date.
Urban is also doing a much better job of connecting with the younger generation, including offering a new mobile app and focusing on increasing e-commerce sales. Both of these are big positives that should help Urban continue taking market share from the teen retailers.
Where Urban wins out
Urban's key initiatives include store expansion and increasing its online and mobile presence. This includes its new interactive mobile app. Its app allows users to upload a photo and sync it with their social networks, and in return users will get reward points for mentioning the brand on Twitter or Instagram. The app also gives users early access to sales and other items, such as concert tickets.
There's still plenty of room for the company to accelerate store openings. It opened only 57 stores in 2012 and plans to open only 49 in 2013. Urban's balance sheet can easily support this because it has no debt and it has cash that covers over 10% of its market cap. The store growth potential goes beyond Urban's North America and Europe store expansion plans to include the fast-growing Asian market.
The other big key for Urban is the potential to expand margins. Its net margin is currently around 9%, but it was 11%-12% prior to the financial crisis. With the help of improved inventory management, which should lead to lower markdowns, Urban believes it can boost margins by 50 basis points in fiscal 2014.
Foolish bottom line
The thing is that the stock looks to be fairly valued, at best. Urban trades at 20 times earnings and 1.8 times sales. That doesn't change the fact that the company has a pristine balance sheet, generates 20% return on invested capital, and it is expected to grow earnings per share at an annualized 16% over the next five years. A deeper pull back would be a great buying opportunity.
Urban Outfitters isn't the only great retailer out there
The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.