Urban Outfitters May Delay Its Expansion In China

Urban Outfitters (NASDAQ:URBN) reportedly opened its first store in Hong Kong last year, marking the beginning of its retail store expansion in Asia following its three-year long wholesale distribution partnership with World Co. Ltd. ^[1] While this raised the probability of a subsequent entry in China, there haven’t been any such plans as yet, and we believe that Urban Outfitters can plan to delay its retail expansion in China for two reasons. Firstly, the market that appears lucrative on the outside in fact is extremely challenging, which can make any retailer think twice before investing. Secondly, the company still has substantial room for expansion in the U.S. and hence, it may not want to pool its resources elsewhere.

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 and tier 2 cities and the dominance of low-cost local players in tier 3 and 4 cities can discourage foreign retailers from expanding aggressively. A retailer usually resorts to international expansion when it runs out of growth opportunities in its domestic markets. However, Urban Outfitters can expand for several years in the U.S. before it feels the need to expand internationally. Hence, we believe that the company may decide to delay its expansion in China, which actually appears an inevitable move.

Our price estimate for Urban Outfitters at $40, implies a premium of close to 15% to the current market price.

See our complete analysis for Urban Outfitters

China Isn’t The Best Bet At The Moment

Difficulty in understanding consumer behavior: One of the biggest challenges for Urban Outfitters in China is to understand the shrewd consumer behavior. Between 2000 and 2005, the 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. ^[2]

Lack of lucrative locations: 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. ^[3] However, expensive real estate and high labor costs in developed cities can discourage investment.

Competition: 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. ^[2] Overall, these factors are enough to deter Urban Outfitters intentions for expansion in the world’s second-largest economy, that has been at its best lately.

The Company Will Rather Invest In The U.S.

Urban Outfitters isn’t the most cash intensive company, but it has a fair amount in its cash reserves – over $300 million in cash and marketable securities. However, the amount isn’t enough for the company to simultaneously invest in domestic store expansion, omni-channel development and international expansion. While the first two investment areas are essential for the retailer’s survival in the U.S., the third one can wait. Unlike other casual apparel retailers in the U.S., Urban Outfitters still has plenty of expansion room available. The graph below shows why.

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. At the end of 2014, Urban Outfitters had 234 stores operational for its namesake brand, 196 stores for Anthropologie and 98 for Free People and other brands combined. We believe that the company will continue to open stores in the U.S., until it has around 800-900 stores operational, a position which other casual apparel retailers deem fit for an omni-channel model.

Hence, the cash Urban Outfitters has will most likely be invested in its domestic store expansion and omni-channel initiatives, and it can take a rain check on its Chinese expansion.

See More at Trefis | View Interactive Institutional Research (Powered by Trefis)

1. Urban Outfitters opens first Asian store in Hong Kong, South China Morning Post, Sept 11 2014 [↩]
2. Winning in China’s Apparel Market, AT Kearney [↩] [↩]
3. China’s City Tier system, Osio China, Nov 16 2012 [↩]