The Two Main Growth Drivers of Urban Outfitters

Urban Outfitters (NASDAQ: URBN  )  pleased its shareholders with impressive third-quarter earnings results. The company increased its sales by 12% to $774 million, while its earnings per share jumped 17.50% from $0.40 last year to $0.47 this year. This double-digit top and bottom line growth was driven by its two main high-growth brands: Anthropologie and Free People.

Anthropologie and Free People are the main growth drivers
The Urban Outfitters brand was the largest revenue contributor for the company, generating sales of $341.9 million in the third quarter. The Anthropologie and Free People brands contributed $310.1 million and $113 million, respectively, in sales during the same period. Anthropologie delivered 16.2% year-over-year sales growth. Free People had the highest sales growth at 29.1%.

Both brands also achieved record growth in retail segment comp rates, with rates of 30% at Free People and 13% at Anthropologie. Interestingly, Urban Outfitters enjoyed an 11 basis point improvement in gross profit due to a reduction in merchandise markdowns and improved initial merchandise margin at those two fast-growing brands.

In addition, Anthropologie also redesigned its website with improved visuals which resulted in strong gains in direct-to-consumer sales. Sales from the Free People wholesale segment rose by 21%, mainly due to the expansion of the new shop-in-shop concept. Urban Outfitters believes that Free People will remain the industry leader because of its creative marketing, customer engagement, and product development.

Urban Outfitters has laid out several initiatives to drive its future growth. It will focus on expanding its retail square footage by opening new stores in North America, growing its direct-to-consumer channel, raising the penetration rate of the company's brands internationally, and expanding the product and category offering.

Both the Anthropologie and Free People brands are increasing their presence abroad. In the third quarter, Free People opened its first two locations in Japan and a shop-in-a-shop location in Hong Kong. The company expects that international expansion will be the main source of growth for the Free People wholesale channel. Anthropologie has found its growth opportunity in Europe, as its fourth U.K. store opened in the third quarter. 

Abercrombie & Fitch and Gap have lower valuations and higher cash distributions to shareholders
Urban Outfitters is valued at 9.5 times EV/EBITDA (enterprise value/earnings before interest, taxes, depreciation, and amortization). However, Urban Outfitters seems somewhat overvalued in relative terms compared to Abercrombie & Fitch (NYSE: ANF  ) and The Gap (NYSE: GPS  ) , which have EBITDA multiples of 5.63 and 6.76, respectively.

Despite the sluggish retail environment, Abercrombie & Fitch continues to expand in emerging economies, especially in Asia. In China, its six Hollister stores produced similar four-wall margins to its European stores, while comp-store sales experienced tremendous year-over-year growth at 40%.

In addition, Abercrombie & Fitch also opened its first Hollister store in Japan at LaLaport Yokohama with great momentum. This store is considered to be in the top 10 Hollister stores in terms of volume. It will open its second Hollister store in December at LaLaport Shin Misato in Tokyo. What investors might like about Abercrombie & Fitch is its decent dividend yield. At the current trading price, Abercrombie & Fitch offers investors a sweet 2.30% dividend yield at a very conservative payout ratio of 28%. 

Gap has also focused on expanding in Asian markets. The company intends to open about 160 stores and close about 80 stores. Store closures will mainly be in North America while there will be more store openings in Asia. Gap has concentrated its year-to-date capital expenditure of $487 million on China, Athleta, Old Navy Japan, and its global outlets.

For the full year, Gap believes it will achieve $2.57-$2.65 in full year EPS, implying a 12% growth rate. In terms of cash return, Gap also has a quite conservative payout ratio of 22% with a decent dividend yield of 1.90%. Moreover, in the third quarter, $900 million of cash was distributed to shareholders via the repurchase of 20 million shares. Gap also announced a major $1 billion share buyback plan, offering investors a 5.4% buyback yield. 

My Foolish take
Anthropologie and Free People could be the two brands which drive Urban Outfitters' growth in the future. However, as it offers no dividends and it has the highest valuation compared to its peers, I would rather wait for the retailer to pull back before initiating a long position. Among the three, I like Gap the most because of its decent dividend yield, conservative payout ratio, and huge upcoming share buybacks. 

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