It's one thing for a company to know its audience. It's another when that company looks down on the very groups that generate most of its revenue. For years, Urban Outfitters (NASDAQ:URBN) has profited off trendy twenty-somethings, who are notoriously fickle by nature. However, after recent comments from the board of directors suggested that customers were angst-ridden, at best, and homeless, at worst, it's easy to wonder whether Urban Outfitters could be headed for disaster.
It all leads to a reasonable question: Could a company that accidentally insults its audience be a good investment?
Usually, in a retailer's annual report or media conference, the company throws around safe, inclusive buzzwords to describe its audience. Coach, for instance, has summed up its key demographics as stylish men and women who have "demands for both fashion and function," according to its most recent 10-K.
Urban Outfitters has also been diplomatic on its 10-Ks, describing customers as "young adults, who are culturally sophisticated, self-expressive and concerned with acceptance by their peer group." That's one way to word it. Another is to say your customer is "the upscale homeless person, who has a slight degree of angst and is probably in the life stage of 18 to 26." That's how CEO Richard Hayne bluntly summed it up to analysts and investors in September 2012.
Other board members aren't innocent, either. The company's executive director, Susan Otto, summed up the entire Urban Outfitters demographic as a generation of followers who didn't even know anything about the pop cultural references they were wearing. "When they were little," she said in a statement last year, "they saw the older kids do something they thought was really cool and they weren't allowed to do it and now that they're adults, it's sort of like ice cream for breakfast, they can do whatever they want now."
One example Otto cited was a classic countercultural '90s cartoon.
Urban Outfitters is selling Beavis and Butthead tees. [Shoppers] probably don't know anything about Beavis and Butthead, but simply remember that being something the older cool kids did and something they were denied.
Urban Outfitters might have made some weird comments, but they don't seem to be affecting its most recent sales. The retailer's annual revenue rose 13% from 2012 to 2013, and even though its operating margin is rather small, at 13%, this is still an increase from 11% last year. Net income margin has gone up, as well, from 7% to 8% in 2013. Urban's sales are up, and the company is getting a little better at retaining its profits.
The retailer's free cash flow is also fairly impressive. At $227 million, cash is up from $93 million last year. Taking a look at P/E, Urban Outfitters actually looks potentially undervalued, with a ranking of 25 compared to an apparel industry average of 57.
However, Urban's P/E of 25 is higher than that of some of its more youth-centric peers -- Abercrombie and Fitch comes in at 17 and Gap at 16. If Urban can continue boosting the amount of profit it retains, it has a chance at looking a little less expensive.
Why does it matter?
The comments made by Urban Outfitters' executives may not damage its investment potential in the short term. Money isn't a present problem for the company, but its comments do prove some telling details -- namely, that the company caters to a demographic practically fated to grow out of itself. Those so-called angsty twenty-somethings will soon reach their (hopefully) more stable 30s, rendering a whole slew of Urban's data useless.
True, Urban's more "mature" brand, Anthropologie, does target a slightly older demographic, but that brand only accounted for 40% of last year's revenue, as opposed to Urban's 47%. Urban needs both brands to excel constantly in order not to fall into obscurity, and that could be a tall order to fill.
The company can't ensure a competitive moat, popularity, or even relevance within the next decade. All it can do is continue its exhaustive research of pop culture, and perhaps recruit a new board as its current one grows older and presumably more out of touch. However, even that won't guarantee longevity.
Urban Outfitters has made billions of dollars off a highly volatile audience. There's no guarantee their attentions won't soon veer elsewhere, and long-term investors may not want to put their money into such an uncertain playing field.
Fool contributor Caroline Bennett has no position in any stocks mentioned. The Motley Fool recommends Coach. The Motley Fool owns shares of Coach. 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.