Is Urban Outfitters Really a Top Pick?

After a look at teen retailers, analyst firm Jefferies is out with bullish outlooks on Urban Outfitters (NASDAQ: URBN  ) , Chico's FAS (NYSE: CHS  ) , and ANN  (NYSE: ANN  ) for 2014. While the firm likes all of these companies, Urban is clearly its top pick... but should it be?

What's Jefferies saying?
First, let's look at Jefferies' rating and price target for each of the three stocks, and its implied upside in 2014.

 Company

Rating

Price Target

Implied Upside

Urban Outfitters 

Buy

$54

42%

Chico's 

Buy

$23

18%

ANN 

Buy

$45

17%

With the exception of Urban Outfitters, it doesn't appear as though Jefferies is expecting breakout gains in this space. To no surprise, it's most bullish on Urban Outfitters, calling it a top pick for calendar year 2014.

Jefferies notes that Urban's mid-single-digit comparable-store sales growth is impressive, and that there is room for margin expansion as the Urban Outfitters brand gains momentum. Finally, the firm expects continued strength from brand Anthropologie.

For Chico's, Jefferies is optimistic regarding management's growth initiatives and the company's long-term growth story.

Lastly, Jefferies also likes ANN's management and its product mix in 2014. The firms notes that ANN outperformed in a year (2013) when its peers struggled, and Jefferies expects continued strength.

Why does Jefferies like Urban?
To answer this question, let's take a look at how each stock is currently priced, and then compare valuations to expected sales growth. This comparison might allow us to identify a value investment opportunity.

Company 

2014 Sales Growth Expectations

Price to 2014 Sales Expectations

Urban

10.9%

1.60

Chico's

8.9%

1.04

Ann

6.6%

0.64

Clearly, Urban is growing fastest, but is also the most expensive. Yet, given the metrics above, it is obvious why Jefferies is so high on Urban Outfitters.

Let's apply some simple math
Urban is expected to grow 22.5% and 65% faster than Chico's and ANN, respectively. If estimates are met, Urban is also 54% and 150% more expensive than Chico's and ANN, respectively, on a price-to-2014-sales comparison.

Therefore, we can identify a rather large disconnect between the level of growth and the premium that's been awarded to Urban Outfitters. Moreover, if we use the same formula to assess earnings expectations and its year-over-year growth, we can see a further disconnect.

 Company

2014 EPS Growth Expectations

Price to Forward Earnings

Urban

15%

17.4

Chico's

19%

16.5

ANN

14%

15.0

As you can see, Urban is once more priced the highest compared to future earnings, but in this case, Chico's is actually expected to improve its bottom line at a faster rate. In particular, Chico's is expected to grow its earnings per share 26% faster than Urban, yet Urban has a 5.5% valuation premium.

While a 5.5% premium is not excessive, it is a lot when you consider that Chico's is growing faster, and then when you incorporate the disconnect in sales growth and valuation, you can see that Urban is not presenting the most value... much less is it "top-pick" worthy.

Which is best?
With all three companies, investors are getting a fast-growing retailer with improving margins.

Jefferies' price target implies upside of more than 100% for Urban relative to Chico's and ANN. Yet, using current prices and fundamental outlooks, Urban appears the most expensive, and that's with it's current stock price.

Therefore, for investors seeking value and upside, either Chico's or ANN is presenting a great opportunity, or at least better than Urban. Moreover, by using the metrics discussed in this article, it seems reasonable that Chico's and ANN will significantly outperform Urban and that Jefferies may have gotten the call backward. 

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