Unlike Others, Urban Outfitters Will Continue To Open Stores

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Downside
42.80
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URBN: Urban Outfitters logo
URBN
Urban Outfitters

While players such as American Eagle Outfitters (NYSE:AEO), Aeropostale (NYSE:ARO) and Gap Inc (NYSE:GPS) are consolidating their respective store networks in the U.S. in the wake of the ongoing online shift, Urban Outfitters (NASDAQ:URBN) doesn’t seem to have any such plans. The company has been opening stores regularly over the past several quarters, which will most likely continue going forward. With buyers in numbers switching to online shopping and visiting fewer stores, store expansion offers very few incentives. However, for Urban Outfitters, store expansion is necessary from the perspective of omni-channel retailing  and incremental revenues from new stores is a bonus. The brand’s presence in the U.S. market is limited to just 179 stores (as of Q3 2014), which is significantly less than what some of its counterparts operate.

We believe that Urban Outfitters will expand steadily in the U.S. until it has a store network sufficient to supplement its direct-to-consumer and omni-channel needs. In the current retail environment, retailers are invariably adopting omni-channel retailing, and are simultaneously consolidating their respective store networks. While a number of them are closing their under-performing outlets to reach a position which they deem fit for an omni-channel portfolio, Urban Outfitters has to go the other way round. It needs to open stores at locations where it does not have any presence, and also at locations which are necessary for the establishment of a seamless distribution network.

Our price estimate for Urban Outfitters stands at $43, implying a premium of about 10% to the market price.

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See our complete analysis for Urban Outfitters Inc.

Omni-Channel Retailing Explains The Need For Continued Expansion

Currently, Urban Outfitters operates 194 stores in North America, out of which, 179 are in the U.S. Apart from California, New York and Texas, the brand does not have a double-digit store count in any other state in the U.S. or even Canada. In comparison, players such as Aeropostale and American Eagle Outfitters operate close to 900 stores in the region. The U.S. apparel market is highly competitive and stands big at more than $300 billion. Therefore, it makes sense for Urban Outfitters to continue its expansion in the region, to better compete with its peers and gain market share by leveraging its store presence and omni-channel portfolio.

Omni-channel retailing refers to providing a seamless shopping experience to buyers, irrespective of the shopping medium they prefer. The idea behind this concept is to provide online shoppers enough incentives to shop at stores and vice-versa. Due to growing Internet penetration, proliferation of smartphones and tablets, and the convenience and incentives of online shopping, U.S. buyers have been making more purchases online. This has led to a drastic decline in store traffic, which has troubled a number of retailers who have a vast network of stores and a relatively smaller online channel. Physical retailers’ business model is such that a surge in their online revenues isn’t enough to drive overall growth. Hence, players across the industry are adopting omni-channel retailing to grow their store and online business concurrently.

Aeropostale had mentioned in one of its earnings call that they consider a network for 750 stores optimum for the U.S. market, keeping omni-channel retailing in mind. However, given that Aeropostale is a mall-based retailer and Urban Outfitters‘ stores are almost twice as large, it may want to stall its expansion after reaching the point of 450-500 stores. The landmark still seems very far and we believe that rather than expanding aggressively like Aeropostale, which opened about 174 stores in during 2009-2012, Urban Outfitters will be cautious in its approach. In fact, between 2010-2013, the brand opened a total of just 54 stores and it added only eight stores during the first three quarters of 2014. Given Urban Outfitters’ historic expansion pace, competitors’ presence and the market potential in mind, we expect the company to open 10 to 12 stores annually for the next several years.

Is There A Possibility Of Aggressive Expansion?

Apart from North America, Urban Outfitters has stores in Europe and Asia. While the expansion in foreign markets is expected to be roughly around the historical rates, there is a possibility that the company can ramp up Urban Outfitters‘ expansion in the U.S. Urban Outfitters‘ counterparts are aggressively deploying omni-channel strategies and most of them have a network big enough to implement them at a large scale. On the contrary, Urban Outfitters‘ small store network can limit its omni-channel reach in the near term, if the expansion remains slow. We believe that the preppy apparel retailer would not want to lag behind its competitors in the omni-channel quest, as its namesake brand is already struggling for growth.

We currently forecast that Urban Outfitters’ global average store count will reach 345 over the next five six years. However, if the retailer boosts its expansion pace in North America pushing the average store count to 400 instead, there can be about 5% upside to our price estimate. We believe that this indeed is a level where Urban Outfitters would want to be five-six years down the line. However, an aggressive expansion has certain risks associated with it such as self-cannibalization and low store productivity, which might discourage the retailer from pursuing such a strategy.

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