Urban Outfitters ( URBN ) had a disappointing Q3 2017, which ended just before the holiday season. Comparable sales of its Anthropologie brand declined by 2.7% and the company's sales and earnings missed consensus estimates. Furthermore, the company has been offering deeper discounts in December ( 30% on clothes and accessories vs. 20% last year ) indicating that inventories are piling up and higher discounts are essential for clearance. According to our estimates, Anthropologie stores account for nearly 40% of the company's valuation. Promotional offers in the U.S. apparel market are likely to keep the margins from this segment low and declining over our forecast period.
However, if the company continues to offer higher discounts, due to slow sales and the accumulation of inventory, its margins can get impacted negatively. If margins decline at a faster pace, it can negatively impact the valuation of the company. In its Q3 2017 earnings call the company mentioned that its Anthropologie and Free People brands had higher markdowns that could not be controlled due to their challenging women's apparel performance. In 2016, the company also opened several large format Anthropologie stores which increased its SG&A (selling and general administrative) expenses in the quarter. These expenses were towards hiring, training and overall execution of these stores. While the company is pleased with the top-line performance of these stores, the high markdowns on the Anthropologie brand indicate a slow inventory turnover. The company is investing heavily on these stores and they account for nearly 40% of its total revenues. The slow performance of this brand can impact the company's revenues and profitability negatively. The company's inventory in Q3 2017 increased by 3% primarily due to an increase in the non-comp inventory to support its new and expanded stores. However, the company expects higher markdowns in Q4 due to higher inventory of the Urban Outfitters brand and higher markdowns of the women's apparel under the Anthropologie brand. This will negatively impact its margins in the short term.
Urban Outfitters is looking to manage its inventory better by achieving a faster turnover and reducing the weeks of supply. A faster speed to market will ensure that the company has lower markdowns and better fashion. We believe that, for all fashion retailers. the speed of time to market is critical for ensuring a quick inventory turnover and faster response to changing fashion needs. Fast fashion retailers such as Zara are gaining due to this strategy, since consumers look for newer inventory every time they visit the store, which is fairly frequent. Higher markdowns will impact Urban Outfitters' margins in the short term. However, if the company is able to take corrective measures to reduce inventory levels and have lower markdowns, this might not impact the company in the long term.
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