Urban Outfitters’ Revenues Grow, But Profit Decline Signals The Inevitable

Urban Outfitters (NASDAQ:URBN) recently reported its Q1 fiscal 2016 results that failed to meet market expectations. Although the company reported positive revenue growth across the segments, it still remained some way behind analysts’ expectations. Urban Outfitters’ comparable store sales increased by a decent 4% with overall revenues at $739 million, which was below the consensus estimates of 5.1% increased and $757 million. It appears that the market was way too optimistic about the retailer’s first quarter growth, despite the fact that store traffic across the industry was significantly down and Urban Outfitters still earns a major portion of its revenues through store sales. Considering these factors, the company’s topline growth does not look too bad, but its bottomline performance was alarming. ^[1]

Weighed down by heavy discounting and overall weak margins of the online segment, Urban Outfitters’ net income fell 12.5% to $32.78 million or $0.25 a share, while analysts were expecting the figure to be around $0.30. The retailer’s gross margins declined, its “SG&A rate” increased marginally, and “other expense rate” increased from 0.05% to 0.3%. These items together weighed heavily on Urban Outfitters’ profits. On the gross margins front, continued discounting and weaker margins from online channel, which has grown relative to the company’s overall size, were the main culprits. The increase in SG&A and other expenses was mainly attributable to additional expenses related to web-marketing and e-commerce technology. ^[2] Following the earnings release, the company’s shares fell by more than 15% in after-hours trading.

Direct-to-consumer’s penetration in the company’s overall business has grown, which is a good news, but it comes with the unavoidable negative margin pressure. By nature, direct-to-consumer is a low margin business and with its continued strong growth, pressure on margins was inevitable. During the quarter, while growth in web revenues contributed positively to Urban Outfitters’ net sales growth, it did raise some concerns for its profitability.

Our price estimate for Urban Outfitters stands at $45, implying a premium of about 10% to the market price. However, we are in the process of updating our model in light of the recent earnings release.

See our complete analysis for Urban Outfitters Inc.

Topline Growth Was Good Barring Anthropologie

Urban Outfitters may have failed to report revenues in line with what the market expected, but its growth was much better compared to other casual apparel retailers in the industry. Total net sales increased 8% with 4% growth in retail comparable sales including e-commerce and 18% rise in wholesale revenues. ^[3] It must be noted that store traffic wasn’t at its best during the quarter, and it was the retailer’s online channel that contributed notably to the growth. Urban Outfitters said that while number of transactions and average units per transaction declined during the quarter, its direct-to-consumer channel continued to outperform with significant positive gains driven by increase in sessions, average order value and session conversions. Every quarter, Urban Outfitters’ web revenues are growing strongly, which is keeping it a step ahead of the industry.

Looking at the individual brand performance, Urban Outfitters’ retail comparable sales growth was positive across the board. The most pleasing aspect of the results was the mainline brand’s return to consistent positive growth. After several quarters of struggle arising from certain merchandise goof-ups, Urban Outfitters finally reported positive comparable sales gains in Q4 fiscal 2015 and sustained this momentum with 5% growth in Q1 fiscal 2016. The brand’s inventory was managed well, which would have helped it operate with fewer markdowns. Free People continued to grow in double digits, both in retail and wholesale segments. On the other hand, Anthropologie reported just 1% growth in retail comparable sales, which was surprising as well as disappointing. The management said that while customer response towards the brand was good for the most part, certain categories such as dresses and accessories weren’t well received. Within dresses, silhouettes, fabrics and prices did not intrigue buyers and certain style misses added to their underperformance. Apart from these, most apparel categories performed very well throughout the quarter, and the brand should be back on track once it addresses the aforementioned shortcomings.

Bottomline Performance Raises Concerns Around Growing Web Penetration

The U.S. retail environment remains highly competitive and promotional, which is driving casual apparel retailers towards consistent heavy discounting. During the quarter, Urban Outfitters’ gross margins fell 141 basis points year over year to 33.3% driven by traffic driving promotional activities and higher delivery and fulfillment expenses coming from a rise in direct-to-consumer penetration.

The retailer is in a predicament here. It is aiming to increase its direct-to-consumer penetration, to survive the ongoing online customer shift and propel overall revenue growth. While increased penetration has had some positive impact on overall growth, it has come at a price in the form of negative pressure on overall margins. On the outside, it appears that direct-to-consumer should have higher margins since it does not have deal with the expenses related to pricey retail stores. However, after factoring in the expenses related to storage, packaging and delivery of online orders, the channel actually accounts for weaker margins as compared to the brick-and-mortar business.

Urban Outfitters wants to earn a higher share of revenues from the online channel, since that is where most of the customers are moving. It is deploying several omni-channel initiatives in-order to leverage its store reach to generate better online sales and vice versa. While improvement on this front will do wonders for the company’s topline growth, it cannot happen without the accompanied pressure on gross and EBITDA margins. In order to dilute this impact, Urban Outfitters may have to search for other avenues to cut its expenses, so its topline and bottomline can move forward at a similar pace.

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1. Urban Outfitters is tumbling after big earnings miss, Business Insider, May 19 2015 [↩]
2. Urban Outfitters’ Q1 fiscal 2016 earnings transcript, May 19 2015 [↩]
3. Urban Outfitters Reports Record Q1 Sales, Urban Outfitters, May 18 2015 [↩]