VCR - Urban Outfitters: Risky But Promising

• URBN is a market leader in a growing market, with a sufficient moat.
• URBN's stock has been hurt by inflation and negative sentiment.  However, its business remains resilient and the effects of a recession might be less severe.
• URBN is trading at an attractive valuation.

Introduction

Urban Outfitters, Inc. ( URBN ) stock fell 31.64% YTD as a result of the current macroeconomic environment. Despite this, I believe that Urban Outfitters' resilience and cheap valuation, combined with possibly a much milder recession, gives room for URBN's stock to grow.

Company Overview

Urban Outfitters is a lifestyle retail company known for consistently capitalizing on the ongoing trends to make the brand attractive to Gen Z and Millennials. As such, core offerings are complemented with apartment decors such as vinyl records and cassettes. By targeting the youth, Urban Outfitters entered the fast fashion market--growing at a CAGR of 7% and estimated to be worth almost $40 billion in 2025 . Their audience also fits well with the transition to e-commerce during the pandemic, as approximately 50% of their sales are no longer from stores. Additionally, the company also outshines competitors like The Gap (GPS) and American Eagle (AEO) because of their unique product diversification - this prevents independent reliance on apparel sales as they also own major companies such as Anthropologie Group and Free People. As a result, almost 50% of sales come from its own brands, giving the company more leverage compared to its peers.

Earnings Analysis

Due to the supply chain disruptions and labor shortage resulting from COVID-19, Urban Outfitters' income statement has taken a hit. In Q1 2023 , Urban Outfitters reported revenue of $1.05B (representing a 13.2% increase YoY) but missed analysts' estimations by $20M. Their decreased revenue resulted in an EPS of $0.33, which also missed expectations by $0.09. Finally, the biggest figure is the 35% cost increase in the Retail segment's comparable inventory-- with the culprits being transportation expenses and material costs.

Can Urban Outfitters Survive A Possible Recession?

Urban Outfitters is staying strong and enduring macroeconomic conditions. In Q1 2023, total sales grew 13% to a record of $1.1 billion, with Retail sales also increasing 11% and Wholesale increasing by 6%. In May, when the market was overly bearish about the impact of a recession, management still confidently promised a 500 basis point improvement to initial merchandise margins ((IMU)). Now in July, the market has realized that it overestimated the impacts of a recession. As a result, consumer discretionary stocks have rallied in recent weeks (Vanguard Consumer Discretionary ETF (VCR) is up over 12% in the past month).

Valuation

Trading at a 7.54x P/E ratio, Urban Outfitters is being valued at a historic low.

In fact, Urban Outfitters traded at a 12.8x P/E even at its lowest during the 2008 recession.

Wall St is also bullish on the stock, as 13 analysts reported by Yahoo Finance give it an average price target of $23.92, and the lowest being $17 (only an 18.9% decrease from its current price).

Risk

Of course, the recession continues to be a looming headwind for Urban Outfitters because of the anticipated effects of lower margins and decreased spending in consumer discretionary industries. If market sentiment changes and inflation turns out to be more pronounced, we could possibly see further declines in price. Still, Urban Outfitters' low valuation and steady growth combined with more optimistic views of the economy could present some upside.

Being in the fast fashion market presents a myriad of risks as well. Not only is the competition cutthroat (especially on pricing), but to be successful means accurately investing in lineups fitted to the latest trends. Failure to do so will have strong effects on sales numbers. Consequently, investors should know that Urban Outfitters is a very volatile stock (with a 5Y Monthly Beta of 1.41), and has become more so in the current macroeconomic state

Recommendation

Investors who are more risk tolerant should consider adding Urban Outfitters to their portfolio because of their sound business and attractive valuation-especially if you think that market sentiment regarding the economy was too bearish in the past months. On the other hand, I suggest that more risk-averse investors avoid URBN as the state of the economy is still uncertain and URBN historically has been volatile. Investors should, however, continue to monitor the stock in case it dips further due as a result of a reverse in market sentiment. For all these reasons, I recommend a "Hold."

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