The momentum in Urban Outfitters’ (NASDAQ:URBN) business continued in Q2 fiscal 2014 despite economic headwinds. The retailer reported a staggering 25% jump in profits, which was better than the market’s expectations.  In a weak quarter for apparel retail, the company’s revenues and comparable store sales increased by 12% and 9% respectively with gross margins up 169 basis points.  This performance can be attributed to strong customer response to its product offerings, fewer markdowns and rapid e-commerce growth. We expect Urban Outfitters’ growth to continue in the near term driven by Anthropologie’s revival, its growing direct-to-consumer business and Free People brand’s sales growth.
Rejuvenated Anthropologie Boosted Sales And Margins
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Until the end of fiscal 2012, Urban Outfitters’ Anthropologie brand was struggling due to surplus inventory which prevented the launch of new products. However, the company started managing its inventory better with the launch of a new technology that allows single view of inventory across channels. This helped it reduce lead times and maintain optimum inventory levels. As a result, Urban Outfitters entered the third quarter with flat comparable inventory levels (excluding inventories for new stores).
With inventory under control, Anthropologie did a product overhaul as it shifted its focus from quirky and preppy look to much sensual and softer feminine look. This resonated well with customers, resulting in a jump in regular priced sales. The brand carried the momentum in the second quarter with fewer markdowns even during July when the entire industry resorted to heavy promotions.  Anthropologie’s comparable store sales improved by 9% due to a strong customer response to products such as soraya maxi dress, swiss dot shirtdress, bijouterie necklace, grace swing dress and seaside blouse. 
We expect the growth to continue as the brand continues to add new trends and maintains discipline over its supply chain. Anthropologie will launch new categories including petite collection and weekend casuals, and will also introduce a wider range of sizes and styles. 
Direct-To-Consumer Business Boost Results
Urban Outfitters’ direct-to-consumer business accounts for about 24% of the retailer’s revenues and has been growing at a rapid pace.  The channel’s growth remained high in Q2 fiscal 2014 due to a 16% increase in new visitors and 51 basis points improvement in the conversion rate.  As a result, its contribution to the retailer’s overall sales grew 356 basis points.  Appealing marketing, omni-channel retailing, increasing product categories and overall market growth are driving this perfformance. eMarketer forecasts annual online apparel sales to increase from $45 billion in 2012 to almost $90 billion in 2016. 
The company has invested substantially in merchandising, image and graphic designs to fill its digital store fronts to create a story telling experience for customers.  Urban Outfitters’ CRM (customer relationship management) marketing which tracks campaigns over different channels has been successful in driving online as well as store traffic.  In June, the retailer launched a new iPhone app which saw over 80,000 downloads.  In addition, the company continued to offer a wider and deeper set of products over the Internet.
Growth Of Free People Is A Promising Sign
Urban Outfitters’ smaller brand Free People, which accounts for less than 10% of the company’s value, saw strong growth during the quarter. Its comparable store sales jumped 38% and revenues from its wholesale channel were up 17%.  Free People’s comparable store sales have been growing in double digits for the past few quarters, and we believe that the brand holds significant long-term promise for Urban Outfitters.
Free People‘s marketing has been effective. The brand engages its customers through blogs, catalogs, websites, events, videos and social media, and customer participation has been encouraging so far.  The brand’s fashion blog FP Me already has a large reader base and is seeing strong growth in its customer registration rate.  Free People recently released its first fashion film ‘Roshambo’, which won three awards at La Jolla Fashion Film festival.  Such marketing efforts allows the retailer to interact with its customers in fun and appealing ways, which in turn positively impacts the sales.
Additionally, Free People provides a viable option for Urban Outfitters’ international expansion. The brand partnered with World Co. Ltd. last year for marketing and distribution in Japan. The initial pop-up shops have delivered promising results and Free People is now set to open its two permanent locations in the region this year.  Moreover, it recently debuted in Europe with a wholesale location in London, where it received tremendous response. This performance is likely to set the tone for the brand’s expansion in the entire region. Free People only has 83 retail stores in the U.S., which indicates good expansion potential. 
Our price estimate for Urban Outfitters stands at $46, implying a premium of about 15% to the market price. However, we are in the process of updating the model in light of the recent earnings.Notes:
- Urban Outfitters Earnings: Higher Sales, Wider Margins, The Wall Street Journal, Aug 19 2013 [↩]
- Urban Outfitters Reports Record Q2 Sales And Earnings, Urban Outfitters, Aug 19 2013 [↩]
- Retailers boost July sales with heavy discounts, promotions, Reuters, Aug 8 2013 [↩]
- Eye Candy: Anthropologie Summer 2013 Collection, Effortless Anthropologie, Apr 29 2013 [↩]
- Urban Outfitters’ Q2 fiscal 2014 earnings transcript, Aug 19 2013 [↩] [↩] [↩] [↩] [↩] [↩] [↩] [↩] [↩] [↩] [↩] [↩]
- Urban Outfitters’ SEC filings [↩]
- Retail Ecommerce Set to Keep a Pace Through 2017, eMarketer, Apr 24 2013 [↩]