Urban Outfitters To Debut In Hong Kong; Mainland China Likely To Be Next Stop

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URBN: Urban Outfitters logo
URBN
Urban Outfitters

As growing competition from fast fashion brands and a consumer spending pullback continue to trouble Urban Outfitters (NASDAQ:URBN) in the U.S., it has turned its attention to international expansion. A recent note published in the South China Morning Post reported that the American clothing chain is planning to open its first Asian retail store in Hong Kong later this month. [1] Although Urban Outfitters entered Asia through a partnership with World Co. Ltd. a couple of years back, this will be the first time it will open a company-operated store. International expansion has become an inevitable move for U.S. retailers as the domestic apparel market is saturating. Moreover, while Urban Outfitters performed exceedingly well last year amid an edgy retail environment, its growth has faltered lately due to some poor merchandise selections. Therefore, extending its presence to certain lucrative Asian markets appears to be a sensible move.

We believe that Urban Outfitters’ debut in Hong Kong will pave the way for its future expansion in China, which has become a hub for western apparel retailers. The second largest apparel market in the world is set to grow at a robust pace driven by a booming middle class and changing lifestyle with growing urbanization. Although Urban Outfitters will most likely remain at the forefront of this growth, there are few factors that can have a mitigating impact in the long run. The Chinese apparel market is highly competitive and consumers are extremely discerning with different needs and demands among different demographics. High operating costs in tier 1 & 2 cities, and the dominance of low-cost local players in tier 3 & 4 cities, discourage foreign retailers from expanding aggressively. Nevertheless, Urban Outfitters should have no trouble with its growth in its initial expansion phase, given that there is a lot to explore in the market.

Our price estimate for Urban Outfitters at $41, implies a premium of about 5% to the current market price.

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See our complete analysis for Urban Outfitters

China is a Lucrative Market

Although the Chinese apparel market is struggling currently on account of a consumer spending pullback, it is set to boom in the long term. With rising disposable income and growing urbanization, the market grew from $110 billion in 2009 to $140 billion in 2012 and is expected to touch $220 billion by 2016. [2] Within the market, men’s and women’s casual wear are among the biggest and fastest growing apparel segments. A 2012 AT Kearney report estimated women’s casual wear market to be at $67 billion and men’s casual wear market to be at $56 billion. The same report projected their CAGR (compound annual growth rate) for the period of 2012 and 2016 at 15% and 17%, respectively. Fashion casual wear sales account for about two-thirds of the overall casual wear sales, which suggests that the addressable market for Urban Outfitters is large at around $95 billion (estimated figure for 2013). The fashion casual wear market is expected to grow at a CAGR of 15% for the next few years, indicating that it will remain ahead of the overall market growth. [3]

During the 1990s, middle-aged Chinese consumers started switching from their work related formal uniform to casual outfits, which propelled growth in the apparel market. For over two decades, Chinese buyers exhibited great interest in lifestyle oriented clothing, due to the availability of wide range of products and brands. Additionally, with rising disposable incomes and growing urbanization, their budget for branded apparel has grown. [3] A substantial rise in the region’s labor costs, an ageing population and increased government regulations were the primary reasons responsible for increasing disposable incomes. Development of rural areas encouraged the local population to look for work opportunities in their vicinity, which prevented migration to urban areas, resulting in fewer workers and more expensive labor.

China’s population is aging and about 243 million Chinese are expected to be above the age of 60 by 2020, which will further add to the labor shortage. [4] The younger generation increasingly prefers college over factory work, which reflects increased awareness of education and the opportunities it affords. Apart from fueling labor costs, this trend is likely to enhance the youngsters’ living standards and likely increase the demand for specialty apparel.

But, it doesn’t Come Without Challenges

One of the biggest challenges for Urban Outfitters in China is to understand the shrewd consumer behavior. Between 2000 and 2005, top 500 domestic brands in China had an average life cycle of just 1.5 years. In addition to the fierce competition in the market, this was attributable to rapidly changing consumer tastes. Among different age groups, consumer preferences vary drastically, which makes it difficult for retailers to target a particular age group. For instance, if a retailer specifically targets the age group of 18-25 years, several loyal customers will outgrow this age range within a few years. Subsequently, their needs will change and they might start shopping at other places. Ultimately, the retailer loses its loyal customer base due to the lack of merchandise relevant to different life stages of a customer. While companies usually operate multiple brands in China to encompass different age groups, doing so won’t be easy for Urban Outfitters, given that it has established itself strongly as a teen apparel brand. [3]

While it may seem that Urban Outfitters has several expansion opportunities at hand, identifying appropriate locations to open stores will be an arduous task. The company might not want to target tier 3, 4 & 5 cities with more than 320 million households for its expansion since disposable income in these regions is low. Moreover, they are dominated by local players who have a superior understanding of the market and strong support from the local government. This leaves six tier 1 cities and more than 60 tier 2 cities with over 54 million households for Urban Outfitters to target. [5] However, expensive real estate and high labor costs in developed cities can have a mitigating effect on Urban Outfitters expansion. Therefore, we believe that the retailer will have to plan its expansion carefully, if and when it decides to enter China.

Fast fashion brands Zara and H&M are challenging several apparel retailers including Urban Outfitters in the U.S., and they are on their way to do so in China as well. These brands have entered tier 1 cities and are planning to grow their business rapidly. Zara operated about 120 stores in China in 2012, which is likely to double in the near future. [3] It may be too soon for Urban Outfitters to be worried about these challenges, but it should carefully analyze them to formulate suitable expansion plans.

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Notes:
  1. Urban Outfitters opens first Asian store in Hong Kong, South China Morning Post, Sept 11 2014 []
  2. B2C Ecommerce Sales Climbs Worldwide, as Emerging Markets Drive Higher Sales, eMarketer, Jun 27 2013 []
  3. Winning in China’s Apparel Market, AT Kearney [] [] [] []
  4. China’s bid to provide care systems for elderly faces hurdles, warn experts, South China Morning Post, Sept 4 2013 []
  5. China’s City Tier system, Osio China, Nov 16 2012 []