URBN - Urban Outfitters: Growth Stock At A Cheap Valuation

2023-12-25 03:31:45 ET

Summary

• URBN has gained significant traction among consumers with its diverse portfolio of brands, leading to impressive revenue and profit growth.
• Q3 FY2024 results showed strong performance, with the Free People brand as the top performer and the Nuuly brand experiencing significant revenue growth.
• Despite a decline in revenues for the Urban Outfitters brand, URBN has shown a positive growth trajectory and has the potential to exceed market estimates in the future.

Investment Thesis

Urban Outfitters, Inc. ( URBN ) is an American lifestyle retailer headquartered in Philadelphia, Pennsylvania. In this thesis, I will analyze its third-quarter results along with its future growth prospects. I will also be analyzing its valuation at current price levels and upside potential in the stock price. I believe URBN has managed to gain significant traction among its consumers across multiple brands under its umbrella. The revenue and profits growth has also been quite impressive, leading me to assign a Buy recommendation for URBN.

Company Overview

URBN is a lifestyle retail company that operates a portfolio of brands catering to the diverse tastes and preferences of young, fashion-forward consumers. The flagship brand, Urban Outfitters, includes products like women's and men's fashion apparel, activewear, intimates, footwear, accessories, home goods, electronics, and beauty products. Anthropologie, another brand under the company's umbrella, offers women's apparel, accessories, intimates, shoes, and home furnishings, as well as gifts, decorative items, and beauty and wellness products. The Free People is a specialty women's clothing brand that provides bohemian fashion that features the latest trends. Its Nuuly brand is a women's apparel subscription rental service.

Q3 FY2024 Result

URBN posted strong first-quarter results, beating the market revenue and EPS estimates by 2% and 6%, respectively. As per my analysis, the Free People brand proved to be the outperformer, with its sales growing 18.2%. All the brands experienced solid revenue growth except Urban Outfitters. One segment that I believe could be a revenue booster for the company in the coming years is its apparel subscription rental service, Nuuly, which recorded a 94% increase in revenues y-o-y. The rental service is gaining ground among young people looking for fast fashion clothes at a low price, which is evident in its subscription base growing 25% to 198,000 active subscribers.

It reported net sales of $1.28 billion , a 9% increase compared to $1.17 billion in the same quarter last year. As I mentioned earlier, the Free People brand proved to be the primary revenue driver, with its sales growing by 18.2% to $331.7 million, compared to $280.6 million in the corresponding quarter last year. I think the investment it made in improving its digital presence, including its website and promotions, has greatly benefitted the company. The Anthropologie brand revenues were reported at $550 million, up 13.5% compared to $484 million in the same period the previous year. The Anthropologie brand experienced a strong increase in its wellness product category, which majorly contributed to this increase. The Nuuly brand revenues were up 94% at $65.5 million, compared to $35.2 million in the same quarter last year. As previously discussed, the consistent increase in the subscriber base and higher demand for the rental subscription model for clothes led to this increase. The Urban Outfitters brand, on the other hand, saw an 11.5% decline in revenues from $367.5 million to $324.3 million. The management did not provide any clarification regarding this decline, but I think the increased focus on the other brands and higher dedicated resources towards them impacted the Urban Outfitters numbers. It reported diluted EPS of $0.88, compared to $0.40 in Q3 FY23. This 120% increase in the net income was a result of high revenue growth and restricted operational costs. The net profit margin for the quarter stood at 6.5%.

Overall, the company managed to impress me on multiple parameters, including revenue growth and expanding gross and net profit margins. The company also presented a positive picture on the inventory front, with inventory levels declining 3% from $743.6 million to $721 million. The decline in inventory levels while experiencing revenue growth reflects better inventory conversion. The management has not provided any future guidance, but the market estimates Q4 FY24 revenues to be in the range of $1.43-$1.47 billion, reflecting a y-o-y increase of 6.5% compared to Q4 FY23 revenues of $1.38 billion and the FY24 EPS is estimated to be in the range of $3.20-$3.30, reflecting a solid 89% increase compared to FY23 EPS of $1.70. I believe it should be able to achieve these targets and even exceed them, given its solid growth trajectory in the past few quarters.

Key Risk Factor

High Lease Liability: As of October 31, 2023, it reported a total lease liability of $1.08 billion. It operates 711 stores with a total of 4,494,000 sqft of space. The majority of this space is leased by the company, resulting in high lease liability. It has managed to handle this high lease payment given the consistent income growth, but during situations like COVID-19, where the company experienced a complete shutdown or a significant slowdown, this high lease liability could negatively impact its performance to an extent where it might not be able to sustain its business. To address this issue, the company has invested heavily in its online store to help reduce its physical footprint, but the risk is still there, and I would recommend investors consider it before investing in the company.

Valuation

URBN is currently trading at a share price of $36.27, a YTD increase of 49.5%. It has a market cap of $3.41 billion. It is trading at a forward GAAP P/E multiple of 11.27x, with an FY24 EPS estimate of $3.22. Comparing this to the sector P/E of 17.9x, I believe it is significantly undervalued at current price levels. Also, when we compare it to its peers focused on youth like Foot Locker, Inc. ((FL)) and American Eagle Outfitters, Inc. ((AEO)), which are trading at forward P/E multiples of 34.16x and 16.42x, respectively, we can clearly see that URBN is highly undervalued compared to its peers despite outperforming them in terms of financial metrics. With a long-term view of 3–5 years, the stock could provide stellar returns. The company is consistently investing in new business segments like apparel subscription services, which could help it increase earnings significantly. I believe it is a great opportunity for investors looking for a growth company at a low valuation.

Conclusion

The consistent revenue growth rate, coupled with improving profit margins, indicates that the company is on the right track. The company has improved its inventory management with significant investment in its online store. It is trading at a cheap valuation with a forward P/E multiple of 11.27x. The company faces the risk of high debt lease obligation, but the overall profile provides a favorable risk-reward profile. Considering all these factors, I assign a Buy recommendation for URBN.

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