Can Urban Outfitters Come Out of Its Slump?

Urban Outfitters struggled in the first quarter, but is a turnaround in the cards for the company?

Jul 16, 2014 at 6:33PM

Urban Outfitters (NASDAQ:URBN) is facing tough times in 2014. The company's stock has declined by close to 10% this year, and it did not post impressive first-quarter results either. Urban has struggled due to rising competition in the apparel retail industry from the likes of American Eagle (NYSE:AEO) and Abercrombie & Fitch (NYSE:ANF).

As a result, its namesake Urban Outfitters brand is struggling. However, the company remains optimistic about its long-term performance, driven by strength in its Free People and Anthropologie brands. Management is undertaking steps to improve sales, but analysts believe that the company will continue struggling in the near term. However, will Urban Outfitters be able to deliver in the long run?

Aiming for a comeback
The company is making aggressive investments to strengthen its business. It opened five new stores in the first quarter, which drove its wholesale segment sales 27% higher from the prior-year period. Going forward, Urban Outfitters plans to open around 35 to 40 new stores during this year, which include 12 new Urban Outfitters stores, 15 new Anthropologie stores, and 12 new Free People stores.

It will launch the Urban Outfitters and Anthropologie brands globally, while it will concentrate the Free People brand in North America. Apart from opening more stores, the company is focused on improving its brand product assortment. Urban Outfitters is now concentrating on customers between 18 to 28 years old.

Looking beyond the short-term pain
Keeping this in mind, the Urban Outfitters management team is working hard to build a fresh product assortment and a marketing plan that will resonate with this customer base. As a result of these initiatives, the company expects its gross margin to decline in the second quarter. Additionally, lower product margins and property expenses, along with the continued weakness in the Urban Outfitters brand, will weigh on its gross margin.

It expects its selling and general expenses to grow at a double-digit rate this year due to investments in technology and marketing initiatives. However, from a long-term perspective, Urban Outfitters' moves should result in customer acquisition and retention. 

International growth
Urban Outfitters has partnered with various companies across different geographies to expand its international business. Its partner in Japan, World Company Limited, has opened five additional Free People stores in Tokyo, Osaka, and Kyoto. In Hong Kong, the retailer has partnered with Lane Crawford to open a shop-in-shop at its LAB Concept locations.

The company is also planning to launch a Chinese language website, which should give the Free People team a better understanding of the Chinese customer. This move will also allow it to access new wholesale shops on the Chinese mainland. 

Looking ahead, Urban Outfitters will also expand its product portfolio to tap the international markets. Its merchant and design teams are working to expand its assortments of shoes, intimate apparel, and dresses for special occasions. The company recently launched Free People Movement active-wear which will complement its apparel assortments. The company expects these strategies to boost sales across its brands. 

Fundamentally strong
Although Urban Outfitters has struggled this year, it is fundamentally well-positioned in comparison with its peers. The stock trades at a trailing P/E ratio of 18, while American Eagle trades at an expensive 36 times earnings. Abercrombie is the most expensive of the lot with a trailing P/E of 86. On a forward P/E basis, all three companies are on an equal footing at a multiple of around 14.8, but Urban's net profit margin and operating profit margin trump those of the other two.  

Urban Outfitters has a net profit margin of 8.7%, while its operating margin stands at 13.24%. In comparison, American Eagle's net profit margin stands at 1.80%, and it has an operating margin of 5.85%. Abercrombie does the worst of the three with a net profit margin of just 0.93% and an operating margin of 4.93%. Urban Outfitters' return on equity of 19.4% is also way better than those of the other two. 

The takeaway
Urban Outfitters is facing short-term weakness, but its impressive strategies indicate that it can get back on track in the long run. The company has a superior valuation in comparison with its peers, and its profit margin is also way better. Finally, Urban Outfitters is a debt-free company with a strong cash position of $341 million. The stock looks fundamentally solid, and it could be a good buy on the drop.

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Shirish Mudholkar has no position in any stocks mentioned. The Motley Fool recommends Urban Outfitters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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