Why Urban Outfitters Stock Is Too Risky

Urban Outfitters (NASDAQ: URBN) shares are down over 40% year to date, underperforming the S&P 500's flat trading over the same period.

Investors should be wary of the stock for a few reasons, all of which can be traced backed to fallout from the coronavirus pandemic. Bumpy reopenings are hurting traffic in the retailer's Free People, Anthropologie, and Urban Outfitters stores. Consumers are focusing on more comfort-based clothing and less on fashion due to fewer events to attend and more working from home. Additionally, the continued economic uncertainty is expected to hurt discretionary spending.

Urban Outfitters store

Image source: Urban Outfitters

Reversals and slower reopenings in some states could hurt store traffic

While retail stores are still open in most states, their traffic and sales will be affected by stricter rules around reopening. Without regular traffic to nearby restaurants and entertainment venues, Urban Outfitters' own stores are likely to see reduced activity. Urban Outfitters, Free People, and Anthropologie are often located in shopping centers, enclosed malls, and upscale street locations.  Many of these centers and malls draw visitors looking to dine out or socialize, in addition to shop.

A number of U.S. states are either reversing or pausing elements of their reopening plans due to new surges in cases of COVID-19 as well. California, for example, has halted parts of its reopening process. On July 13, Governor Gavin Newsom ordered the statewide closure of indoor dining rooms, bars, and many entertainment venues. He also ordered some counties to shut down gyms, spas, and churches. Other states, such as New Jersey, paused their current phases of reopening with some delaying indoor dining indefinitely.

While all of Urban Outfitters' stores were closed on March 14, some began reopening in May, and about two-thirds were up and running again as of early June. Traffic and sales have rebounded slowly. The company's digital business performed well during the period. CEO Richard Hayne commented on a June 2 shareholder call: "Online traffic and conversion have exploded in the past 8 weeks. We believe strong double-digit underlying demand could continue throughout the second quarter."

Consumers may favor value over fashion

Given the uncertainty around the economy in the U.S., shoppers may choose to put off purchases or spend their dollars at stores focused on value. The unemployment rate in June 2020 was 11.1%, higher than levels reached during the Great Recession. Beyond the loss of jobs, the potential decrease in consumer confidence will likely lead to delayed or fewer discretionary purchases on items like fashion apparel.

Urban Outfitters' management team sees the current weak economy as different than in past downturns like the Great Recession of 2008. During an April presentation, CFO Francis Conforti noted that in prior recessions, Anthropologie would see demand soften first, but there was more uncertainty this time around.

Conforti elaborated, "We've seen sort of that Anthropologie brand start to be impacted earlier and then Urban Outfitters later as a lot of families try and protect their children from change in spending behavior and patterns. That being said, I just don't know if that's going to be applicable this time around. I just think things are very different right now."

Consumers are focusing on more comfort-based clothing

As higher numbers of people are working from home due to COVID-19, they are buying more comfort, lounge-type clothing over fashion or business casual styles. On the fiscal first-quarterearnings call Hayne noted, "We have seen different results by category and by brand. Home product and casual apparel like activewear, lounge, renewal and knit tops are overperforming, while dressier apparel and special occasion products are underperforming."

Furthermore, there are fewer special events and social occasions to attend with entertainment and dining still far from returning to pre-pandemic levels. Going out to dinner, concerts, or other events likely helps drive some purchases of the types of clothing and accessories offered by Urban Outfitters. Now that many of these events are again on hold, retailers lose out on any corresponding sales. Hayne affirmed this challenge during the call:

[T]he way I'm thinking about [fashion] now is more about the function of fashion and how the functionality drives what people are looking for. And currently, many of the functions that drive apparel, particularly apparel purchases, many of those functions are no longer either -- well, many of them are barred altogether. And so there's not a lot of reason for people to buy the fashion when they can't use it for the function. When the functions come back, I assume the fashion -- the demand for those types of fashion will come back. Until that time, they won't, I cannot predict when it will [come] back.

Overall, Urban Outfitters is facing headwinds around shopper preferences and a challenging environment for consumer spending. Even if the stock has underperformed the overall market by a wide margin, investors should hold off on buying shares at this time -- a prompt recovery is far from certain.

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Pearl Wang has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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


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