URBN - Urban Outfitters: Nuuly A Promising Growth Driver But Risks Are Significant

2023-08-12 01:33:04 ET

Summary

• Urban Outfitters has remained resilient despite sluggish consumer spending, with revenue growth and margin improvement.
• The company's relatively affluent customer base and low wholesale exposure support its near-term outlook.
• Nuuly, Urban Outfitters' apparel rental business, is seeing strong traction and could be a significant long-term growth driver.
• Execution risks could thwart Nuuly's growth trajectory, and fashion risks  could hinder financial performance.

American lifestyle retailer Urban Outfitters (URBN) has remained resilient despite sluggish consumer spending. The momentum could continue near term and longer term, Nuuly could be a potentially lucrative growth driver. However risks are significant.

Background

Despite sluggish macro conditions and touch comps (FY2022 i.e., year ended January 2022 was a strong year for retailing in general driven by government stimulus and high consumer savings post pandemic), Urban Outfitters has so far delivered decent results; revenue growth has been gradually accelerating over the past few quarters (up 3.88% YoY, 3.9% YoY, and 5.8% YoY during the quarters ended October 2022, January 2023, April 2023 respectively) and margins have shown sequential improvement (gross margins rose from 30.5% during the October 2022 quarter to 33.3% during the April 2023 quarter).

Relatively affluent customer base, low wholesale exposure support near term outlook

A few factors could support Urban Outfitters' ongoing momentum near term. The company's portfolio of brands target a more affluent customer base who are relatively resilient to economic headwinds. Anthropologie Group, the company's biggest brand group accounting for 41% of revenues, continues to record robust results (revenues up 12% YoY during the April 2023 quarter after a 10% You growth last year). Free People Group, which accounts for 23% of revenues, is also going strong with revenues up 11% during the April 2023 quarter after notching a 10% YoY growth last year. Urban Outfitters Group, the company's second-largest brand is the only laggard, partly due to the brand's teen and young adults target market being relatively more impacted by macro headwinds (Urban Outfitters Group targets youths aged 18-28 versus Anthropologie Group which largely targets women aged 28-45, and Free People Group which targets women aged 25-30).

In addition, Urban Outfitters has a relatively low exposure to the wholesale segment which is currently depressed due to very weak consumer spending. Strength in its larger retail business (which accounts for over 90% of revenues) could continue outweighing wholesale revenue declines.

Moreover, Urban Outfitters' brand portfolio currently appears to be on trend and resonating well with customers. While rivals like Gap ( GPS ), and Gap-owned Banana Republic are shutting stores , Urban Outfitters is slowly but steadily expanding its store network (primarily for Anthropoligie and Free People) with plans to increase its owned-store count to 719 in FY2024, not including the planned addition of two new franchise stores in the Middle East, bringing the total franchise store count to 10 from 8 currently.

Nuuly, a potential long-term revenue and profit growth driver

Given the fleeting nature of the fast fashion industry which Urban Outfitters is not immune to, the company's long term prospects are uncertain. However Nuuly, their apparel rental business which debuted in 2019, is seeing strong traction; revenues rose 158% YoY in FY2023, accelerating from 107% the previous year. Momentum has remained robust so far with revenues up 125% YoY during the April 2023 quarter and prospects are optimistic. The apparel rental market is a sunrise industry as a proliferation of fashion vlogs and influencers drive fast fashion while consumer sustainability concerns drive interest in renting rather than owning clothes (apparel and footwear is one of the most carbon-intensive industries, generating around 8%-10% of global carbon emissions, even higher than emissions from the aviation and shipping industries combined).

Apparel rental platforms are not new but Nuuly stands out among competitors for several reasons. From a market positioning standpoint, Nuuly's focus on trendy, upmarket brands (including parent company Urban Outfitters' own brands, as well as third party brands like Levi's) differentiates itself from competitors like Rent the Runway ( RENT ) (which focused on luxury labels like Christian Dior and Balenciaga), and Armoire (which arguably is not particularly focused on trendy clothing).

Other apparel brands such as American Eagle ( AEO ) and Vince have rolled out their own apparel rental platforms but they tend to focus on their own brands rather than including third-party brands. Although both may take a page from Urban Outfitters and open the platform to outside brands, at this point they don't seem to be significant threats to Nuuly given their different target markets and price points; American Eagle's products are generally more affordable and accessible compared to Urban Outfitters, rendering the case for renting a lot less appealing. Meanwhile, Vince caters to the luxury segment so they would most likely compete against Rent the Runway rather than Nuuly.

From an operational standpoint, Nuuly boasts certain competitive advantages as well. As part of Urban Outfitters' umbrella, Nuuly benefits from relatively lower fulfillment and inventory costs (by sharing parent company Urban Outfitters' existing inventory and fulfillment infrastructure) as well as lower customer acquisition costs (by leveraging Urban Outfitters' existing customer base to drive memberships). Nuuly's competitive advantages have already delivered results; the platform has about 167,000 active subscribers already ahead of Rent the Runway (which counts 145,000 active subscribers) despite minimal promotion and subscribers are projected to grow to 200,000 by year end. In addition, unlike Rent the Runway which is currently loss making, Nuuly is almost at break-even and the management expects the business to turn a profit by the end of the year.

Synergies between Nuuly and Urban Outfitters are worth highlighting as well; Urban Outfitters gains an additional direct-to-consumer sales channel and the company could benefit from increased brand equity in terms of sustainability .

With the platform still at early stages, Nuuly could soon become a significant growth engine for Urban Outfitters, considering the platform's potential to expand beyond apparel and to other categories and possibly internationally as well.

Risks

Execution risks

Anticipating a growing subscriber base for Nuuly, Urban Outfitters is currently expanding their fulfillment network to cater to a projected 600,000 subscribers in the long run. Rather than striking partnerships, Urban Outfitters is playing the long game and building much of this infrastructure in-house, from the ground up (driving up CAPEX which is projected at $230 million for FY2024 up 15% from $199 million the previous year). Execution risks could hamper returns on the company's investments, whether through delays, costly overruns or subscriber numbers falling short of projections.

Fashion risks

Nuuly still accounts for just a fraction of revenues (under 5%) so the company's medium term performance still hinges largely on its fast fashion retail business which could be volatile due to changing trends. Fashion missteps could result in significant revenue and profit losses, hampering financial performance as well as possibly halting Nuuly's growth initiatives.

Conclusion

Urban Outfitters has a moderate buy analyst consensus rating.

With a forward P/E of 13 , Urban Outfitters is on par with rivals like Levi Strauss & Co (forward P/E 13 ) (LEVI), American Eagle (forward P/E 14.9 ), and The Gap (forward P/E 16.2 ). The company is trading at a discount to its five-year average of 29 despite decent performance amid industry weakness and potentially attractive long term prospects driven by Nuuly which could not only deliver returns on a stand-alone basis but could also generate added value through synergies between Urban Outfitters.

However, despite relatively resilient performance lately, with the exception of Gap, Urban Outfitters' profitability metrics still lag behind rivals (who in contrast are weighed down by outsized exposure to short term wholesale weakness) and fashion and execution risks could jeopardize Nuuly's growth which is still at very early stages. The risk-reward is not compelling at this point, so the stock could be viewed as a hold for investors willing to tolerate the risks.

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