Clothing and accessories retailer Urban Outfitters (NASDAQ:URBN) reported Q2 FY2023 results topping analysts' expectations, with revenue up 7.5% year on year to $1.27 billion. Urban Outfitters made a GAAP profit of $104.1 million, improving from its profit of $59.5 million in the same quarter last year.
Urban Outfitters (URBN) Q2 FY2023 Highlights:
- Revenue: $1.27 billion vs analyst estimates of $1.25 billion (1.87% beat)
- EPS: $1.10 vs analyst estimates of $0.88 (24.8% beat)
- Free Cash Flow of $129.4 million, up from $16 million in the same quarter last year
- Gross Margin (GAAP): 35.8%, up from 31.7% in the same quarter last year
- Same-Store Sales were up 4.9% year on year
- Store Locations: 264 at quarter end, increasing by 3 over the last 12 months
Founded as a purveyor of vintage items, Urban Outfitters (NASDAQ:URBN) now largely sells new apparel and accessories to teens and young adults seeking on-trend fashion.
In addition to being trendy, the aesthetic tends to also be edgy and creative. Skaters and art students can be thought of as embodying the Urban Outfitters style. In addition to clothing and accessories such as beanies, socks, and bags, the company also sells unique items such as home decor and vinyl records to augment its aesthetic.
A typical Urban Outfitters store is roughly 10,000 square feet and located in both urban and suburban shopping centers as well as close to places with a high density of young consumers such as college campuses. The stores don’t usually follow typical retail layouts and are designed to be more edgy and nonconformist. There can be some initial difficulty navigating a store but the upside is more exploration and wandering.
In addition to the core Urban Outfitters brand, the company also operates Anthropologie and Free People. Anthropologie sells women’s clothing, accessories, and home decor featuring a bohemian aesthetic. Free People is a similar brand to Anthropologie but strictly focuses on apparel and accessories. All Urban Outfitters brands have an ecommerce presence that gives customers multiple ways to shop, return, and exchange merchandise.
Apparel sales are not driven so much by personal need but by seasons, trends, and innovation, and over the last few decades, the category has shifted meaningfully online. Retailers that once only had brick-and-mortar stores are responding with omnichannel presences. The online shopping experience continues to improve and retail foot traffic in places like shopping malls continues to stall, so the evolution of clothing sellers marches on.Retailers offering casual yet trendy apparel for men, women, and children include H&M (OM:HMB), Inditex (BME:ITX) which owns Zara, Abercrombie & Fitch (NYSE:ANF), and American Eagle Outfitters (NYSE:AEO).
Urban Outfitters is a mid-sized retailer, which sometimes brings disadvantages compared to larger competitors benefiting from better economies of scale. On the other hand, it has an edge over smaller competitors with fewer resources and can still flex high growth rates because it's growing off a smaller base than its larger counterparts.
As you can see below, the company's annualized revenue growth rate of 5.92% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was mediocre as it opened new stores and grew sales at existing, established stores.
This quarter, Urban Outfitters reported solid year-on-year revenue growth of 7.5% and its revenue of $1.27 billion outperformed analysts' estimates by 1.87%. Looking ahead, the analysts covering the company expect sales to grow 3.53% over the next 12 months.
Same-store sales growth is an important metric that tracks demand for a retailer's established brick-and-mortar stores and e-commerce platform.
Urban Outfitters's demand within its existing stores has generally risen over the last two years but lagged behind the broader consumer retail sector. On average, the company's same-store sales have grown by 7.11% year on year. Given its flat store count over the same period, this performance could stem from increased foot traffic at existing stores or higher e-commerce sales as the company shifts demand from in-store to online.
In the latest quarter, Urban Outfitters's same-store sales rose 4.9% year on year. This growth was an acceleration from the 1% year-on-year increase it posted 12 months ago, which is always an encouraging sign.
Gross Margin & Pricing Power
We prefer higher gross margins because they not only make it easier to generate more operating profits but also generally indicate product differentiation, negotiating leverage, and pricing power.
As you can see below, Urban Outfitters has averaged a weak 31.4% gross margin over the last eight quarters. This means that the company makes $0.31 for every $1 in revenue before accounting for its operating expenses.
In Q2, Urban Outfitters's gross profit margin was 35.8%, marking a 4.2 percentage point increase from 31.7% in the same quarter last year. This margin expansion was comforting to see as it could signal that the company was operating in a less competitive environment with higher pricing power, less pressure to discount products, and more stable input costs (such as distribution expenses to move goods).
Operating margin is a key profitability metric for retailers because it accounts for all expenses that keep the lights on, including wages, rent, advertising, and other administrative costs.
In Q2, Urban Outfitters generated an operating profit margin of 10.4%, up 3.1 percentage points year on year. This increase was encouraging and likely driven by stronger pricing power, as indicated by the company's larger rise in gross margin.From an operational perspective, Urban Outfitters was profitable but held back because of its expense base over the last two years. The company has produced an average operating margin of 6.34%, mediocre for a consumer retail business. However, Urban Outfitters's margin has remained more or less the same, highlighting the consistency of its business.
These days, some companies issue new shares like there's no tomorrow. That's why we like to track earnings per share (EPS) because it accounts for shareholder dilution and share buybacks.
In Q2, Urban Outfitters reported EPS at $1.10, up from $0.64 in the same quarter a year ago. This print beat Wall Street's estimates by 24.8%, a welcome development that should delight shareholders.
Between 2020 and 2023, Urban Outfitters's adjusted diluted EPS flipped from negative to positive. These results show that the company is headed in the right direction as profitability is vital for success in the challenged consumer retail sector.
Cash Is King
Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can't use accounting profits to pay the bills.
Urban Outfitters's free cash flow came in at $129.4 million in Q2, up 710% year on year. This represents a 10.2% margin, which is 8.8 percentage points higher than its free cash flow margin in the same period last year.
Over the last eight quarters, Urban Outfitters has shown mediocre cash profitability, putting it in a pinch as it gives the company limited opportunities to invest organically into its business, pay down debt, or return capital to shareholders. Its free cash flow margin has averaged 0.39%, subpar for a consumer retail business. However, its margin has averaged year-on-year increases of 7.3 percentage points, a great result that should improve its prospects.
Return on Invested Capital (ROIC)
Urban Outfitters's subpar returns on capital may signal a need for future capital raising or borrowing to fund growth. Its five-year average return on invested capital (ROIC) is 8.58%, low compared to the best retail companies that consistently pump out 25%+.
We like to track ROIC because it tells us how much return (profit) a company makes on the money it invests into its business, shedding light on its prospects and its management team's decision-making prowess. ROIC can also be used as a tool to benchmark a company's performance versus its peers, and just like how we focus on long-term investment returns, we care more about analyzing a company's long-term ROIC because short-term market volatility can distort results.
Key Takeaways from Urban Outfitters's Q2 Results
With a market capitalization of $3.3 billion, Urban Outfitters is among smaller companies, but its $475.6 million cash balance and positive free cash flow over the last 12 months give us confidence that it has the resources needed to pursue a high-growth business strategy.
We were impressed by how significantly Urban Outfitters blew past analysts' EPS and free cash flow expectations this quarter, driven by its outperformance in same-store sales and strong improvement in gross margin. That really stood out as a positive in these results. Overall, this was a favorable quarter for Urban Outfitters. The stock is up 2.64% after reporting and currently trades at $35 per share.
Is Now The Time?
When considering an investment in Urban Outfitters, investors should take into account its valuation and business qualities as well as what happened in the latest quarter. We cheer for everyone who's improving the lives of others but in the case of Urban Outfitters, we'll be cheering from the sidelines. Its revenue growth has been mediocre, and analysts expect growth rates to deteriorate from there. On top of that, unfortunately its relatively low ROIC suggests suboptimal profitability prospects and its gross margins make it more difficult to reach positive operating profits compared to other consumer retail businesses.
While it's trading at a reasonable price and we've no doubt one can find things to like about Urban Outfitters, at the moment, we think there might be better opportunities in the market.
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