Urban Outfitters Coming Out Of A Funk

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In tatters a year ago, niche-brand lifestyle retailerUrban Outfitters ( URBN ) is on the mend.

The turnaround comes on the heels of a management shake-up, ongoing efforts to fix fashion missteps and gains in e-commerce.

Evidence has been building since Urban Outfitters' second-quarter earnings report on Aug. 21, when six straight quarters of flat or plunging earnings were reversed as profit jumped 20% from the year-ago period, sending shares soaring 18%.

Same-store sales also showed improvement, though they were still way down from the company's double-digit heyday years. Total revenue grew 11% to $676 million.

A more recent update in an SEC filing on Sept. 10 said that third-quarter comparable retail net sales were so far trending "mid-single-digit positive" from a year earlier.

Management will give further business updates in a highly anticipated "analyst day" on Sept. 27. If the news is positive, shares could get a further lift, analysts say.

"They are on a slow, methodical turnaround," said Robin Murchison, a SunTrust Robinson Humphrey analyst. "The investment community has adjusted expectations from super-strong growth to a little more methodical growth."

New Management

Early in the year, co-founder Richard Hayne replaced CEO Glen Senk, who resigned. And Ted Marlow returned to lead the company's namesake Urban Outfitters Group.

The Urban Outfitters division targets young men and women 18 to 28 with an eclectic mix of trendy apparel, footwear, accessories and apartment ware. Anthropologie is geared to "sophisticated and contemporary" women 28 to 45, the company says.

A third concept, Free People, offers private-label contemporary casual apparel for young women through its namesake stores and sells wholesale to department and specialty stores.

"When they first came on the scene (in the early 1970s) they created a niche not really out there except for the boutiques," Murchison said. "The company goes out and creates a niche vs. reacting to a niche."

As of July 31, the company operated 207 Urban Outfitters, 173 Anthropologie stores and 72 Free People stores.

Two other concepts are still in early stages, with two stores each: Wedding concept BHLDN and garden center Terrain.

So what went wrong at the onetime high-growth retail company? The economy didn't help. But most observers point fingers at merchandising missteps, which caused sales to slow, especially at Anthropologie. And excess inventory last year led to sharp markdowns.

Meanwhile, without new fashion trends to drive sales, Urban Outfitters' brands lost their edge, analysts say.

"They had a really strong four-year cycle from 2007 to 2010," said JP Morgan analyst Brian Tunick. "Dresses were a very hot trend. It was the beginning of premium denim. Skinny (pants) started in late 2009 and 2010. The department stores and specialty stores didn't catch up for a while so it was their business to be had."

But in 2011, the company had trouble driving further volume and made "some wrong fashion bets," Tunick said.

"Once fashion wasn't resonating and there was too much inventory, there was nowhere to go but down," he said.

Tunick says one problem with being ahead of the curve is that Urban Outfitters lost some of its uniqueness as others copied it.

"American Eagle Outfitters ( AEO ) started to offer more third-party brands and accessories.Francesca's ( FRAN ) has taken somewhat of a page out of (Urban Outfitters). And some department stores also have become a little more unique in trying to win over (their kind of) customer.

"It's getting harder to stay cool and hip as the landscape has gotten better," Tunick said.

In addition, the Internet made it easier for smaller brands to gain traction quickly, he says. He cites Wisteria, Nasty Gal and LuLu's as examples.

"Online is the wild, wild west right now, with people coming and going and making big splashes. We'll see in a couple of years how the flash sites are going, the Gilt Groupes and Rue La La's."

Murchison says a new silhouette to match the impact of skinny jeans would especially benefit Anthropologie. "When there's a trend out there they are early to market. That's what their customer comes to them for," she said.

"Urban Outfitters was not as bad and got on track sooner than Anthropologie," she added. "Anthropologie is still trying to prove itself but the fashion concept has improved."

Murchison says colored pants, prints and patterns are starting to resonate with customers.

In second-quarter commentary, management cited colored denim and other bottoms as well as dresses as bright spots across brands. Also, tighter inventories led to lower markdowns.

Observers are still looking for more meaningful gains in margins, which have fallen off sharply from their peak.

"Their operating margins over the last 10 years have averaged 15% to 16% but last year they were under 12%," Tunick said. In the most recent quarter, the operating margin was 14.2%.

Following a 26% fall in earnings last year, analysts expect profit to rise 33% this fiscal year to $1.58 a share and grow 21% the next year, according to a Thomson Reuters poll.

Online Sales

The fast-growing Web business has been getting special attention as management seeks to make the higher-margin business as much as 50% of total sales over time.

Direct-to-consumer sales account for a hefty 20% of revenue, much more than for most retailers.

The firm is gearing up a "pick, pack and ship" program that lets it fulfill online orders from any store or distribution center in the U.S. Management says the initiative could account for "many millions of dollars" in added sales in the second half of this year.

Analysts expect international expansion to become a more meaningful contributor as the global economy improves.

European operations have softened due mostly to weakness in the company's London stores. But CEO Hayne stated that they are not "Euro-skeptics" and would continue to invest there.

Meanwhile, management expects to open 51 new stores this fiscal year. They'll be split among Urban Outfitters (18), Anthropologie (16), Free People (15) and one each for BHLDN and Terrain.

"Terrain has been incubating for several years," Murchison said. "I think it's a lovely concept. I question whether it can make money."

"The more intriguing one to me is the wedding concept, BHLDN," she added.

Morgan Stanley named Urban Outfitters a "top 2012 pick." And Janney Capital Markets considers the company a "back-half 2012 turnaround story," driven by reduced markdowns and improved products at the two biggest divisions.

Said JP Morgan's Tunick: "There's no question that the worst is behind (them). Now we're starting to see some more optimism."



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: AEO , FRAN , URBN

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