Struggling mall apparel retailer Urban Outfitters (NASDAQ:URBN) reported surprisingly strong second quarter numbers that smashed depressed expectations. URBN stock popped on the news in late August.
Comparable sales dropped just 13% in the quarter versus a 28% drop in the first quarter. Comparable sales at the Free People brand actually rose 11%. Gross margins rebounded from 2% in Q1 to 29% in Q2. The SG&A rate fell almost 400 basis points. Operating margins expanded in the quarter. Management commented on the conference call that August sales and traffic trends are steadily improving relative to July and the second quarter.
All in all, it was a solid quarter which broadly underscored that Urban Outfitters is in rebound mode.
Accordingly, URBN stock is also in rebound mode. Coming into the earnings report, shares were trading down about 30% for the year. On the heels of Q2 earnings, Urban Outfitters stock has surged more than 20% higher.
I think you stick with this rally for three reasons:
Urban Outfitters is the cream-of-the-crop in mall apparel retail, and the company’s strong performance in the quarter enabled management to advance strategic growth initiatives at the same time that peers are struggling to stay afloat. Consumer spending on discretionary items like apparel will continue to recover over the next few months, providing a tailwind for Urban’s already-improving sales trends. Thanks to recovering sales trends and rebounding margins, URBN stock remains cheaply valued, even after its post-earnings surge.
URBN Stock Cream-of-the-Crop in Mall Retail Sector
I’ve long held the belief that Urban Outfitters is the best in the business when it comes to mall retailers.
The company is supported by three brands with strong brand equity — Urban Outfitters, Free People, and Anthropologie — all three of which make their own line of exclusive, trend-forward clothes that strongly appeal to young consumers. The store presentations are also very relevant and hip. Urban also has one of the strongest and most robust digital businesses in mall retail.
All in all, Urban Outfitters is a top-notch retailer. Second quarter earnings confirmed that. While everyone else in this space is dealing with 20%-plus comparable sales drops, eroding margins, and huge cash burn, Urban Outfitters saw comparable sales fall just 13%, profit margins expanded, and the company actually printed a profit in the quarter.
Because of the company’s out-performance during the crisis, management has the resources to push forward on strategic growth initiatives during these unusual times, such as paying down debt, buying back shares, opening new stores, healthily clearing inventory, and optimizing omni-channel capabilities. By comparison, all of Urban’s peers are barely staying afloat.
The implication, of course, is that exiting the Covid-19 crisis in 2021/22, Urban Outfitters will be in a far, far better position than everyone else in this space. The company’s growth trajectory could actually accelerate because many of its peers will likely go under, giving Urban a compelling opportunity to expand market share in 2021/22.
Rebounding Consumer Spending
Management commented on the conference call that August sales trends are improving relative to July and the second quarter, an improvement that should persist for the foreseeable future.
The reality is that America is finally mastering the Covid-19 balancing act, where we sustain economic normalcy and keep virus risks mitigated by doing things like moving retail stores outside, converting curbside parking into outdoor restaurant seating, and re-purposing parking lots and streets into open air markets. As these smart preventive actions have been adopted broadly, we’ve seen consumer spending rebound over the past few months and we’ve seen Covid-19 cases drop.
It’s a best of both worlds scenario.
Consumers, businesses and legislators alike will only get better at this balancing act over the next few months. As they do, current trends will persist. Consumer spending will continue to rebound. Covid-19 cases will continue to drop.
Importantly, that means Urban Outfitters’ comparable sales trends will continue to improve towards pre-Covid levels over the next few quarters.
Urban Outfitters Stock Remains Cheap
Despite the 20% post-earnings pop, URBN stock remains cheap.
Prior to earnings, my model on Urban Outfitters called for sales to rebound sharply in 2021, and then grow at a steady 3% to 4% compounded annual growth rate thereafter into 2025. I also modeled for gross margins to recover somewhat, but not entirely, and for SG&A deleverage to be a headwind.
Urban’s second quarter earnings broadly confirmed that my top-line assumptions for the company are reasonable.
However, earnings also implied that — thanks to rent negotiations wherein Urban Outfitters is seeing some success is talking down rent costs — gross margins will be able to expand to above pre-Covid levels within the next few quarters. At the same time, the earnings report also implied that Urban Outfitters is learning how to sell a lot of product on a slimmed down opex base, and that SG&A leverage will be a tailwind going forward.
Because of that — and factoring in the newly announced share buyback program — I’m upping my 2025 earnings per share estimate on Urban Outfitters from $2 to $3.
Over the past five years, the market’s forward earnings multiple has averaged around 17x. Based on that average multiple and a 10% annual discount, $3 in 2025 earnings per share implies a 2020 price target for URBN stock of roughly $35.
Bottom Line on URBN Stock
Urban Outfitters is proving to the market that it’s not just another struggling mall retailer. This is the best retailer in the mall world.
URBN stock is consequently rebounding. This rebound will persist because the fundamentals are solid, growth trends are favorable, and the valuation remains discounted.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not hold a position in any of the aforementioned securities.
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