Urban Outfitters Earnings: An Interesting Restaurant Acquisition Follows Disappointing Results

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URBN: Urban Outfitters logo
URBN
Urban Outfitters

Urban Outfitters (NASDAQ:URBN) disappointed with its Q3 fiscal 2016 growth and announced one of the strangest acquisitions in the apparel retail history. After missing estimates on comparable sales growth by a long margin, the company unveiled its agreement to acquire The Vetri Family group of restaurants along with the award winning Pizzeria Vetri for an undisclosed amount. [1] Urban Outfitters has been known to think outside the box for its product design and selling strategies. What has been offensive to many has often turned out a USP (i.e., Uniquie Selling Proposition) for the retailer. The company appears to have extended its unorthodox approach to its business strategies as well, buying a food enterprise to complement its apparel business.

Urban Outfitters feels that not only would it benefit from direct spending on Vetri restaurants, they could even help improve cross selling, provided the company plans to integrate the two concepts. However, investors don’t appear too fond of this idea, speculating that a restaurant business can dilute the management’s focus on its mainline business, which can impact its growth further.

Over the past few years, store-based casual apparel retailers have struggled to attract customers amid rising competition from fast-fashion players and consistent customer shift towards the online space. Their orthodox revival strategies centered on merchandise design and pricing have failed to bear fruit, as U.S. buyers are just not spending as much on clothing as they did a few years back. This is why Aeropostale (NYSE:ARO) entered the home textile business with brand licensing and Urban Outfitters is buying a pizza chain.

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Our price estimate for Urban Outfitters stands at $38, which is significantly ahead of the current market price. However, we are in the process of updating our models in light of the recent earnings release.

See our complete analysis for Urban Outfitters

Q3 Highlights

Urban Outfitters has been struggling for some time now as buyers in number have moved to fast-fashion brands such as Zara and Forever 21. Even during the third quarter, comparable store sales growth was lackluster at just 1%, well below the expected figure of 3.4%. Overall sales in Q3 increased 3% to $825 million, which was almost $40 million behind the consensus estimates. This led to a sizable fall in the company’s stock price. This appears a market overreaction considering that Urban Outfitters’ gross margins improved 11 basis points with fewer markdowns for the namesake brand. Even the retailer’s SG&A rate fell a little and it was able to meet market expectations on earnings per share. [2] It seems that shareholders responded negatively to Urban Outfitters’s weaker than expected growth and the fact that it bought a restaurant chain. While many are skeptical about this move, we believe that a restaurant business can work well for Urban Outfitters.

How Would A Restaurant Business Complement Urban Outfitters

Urban Outfitters is not new to the restaurant business as some of its stores operate an in-store coffee shop, as a means to attract traffic. In addition, it has co-located key stores with various restaurant formats targeting its youthful clientele—e.g., its Space 24 project to be located across from the University of Texas, Austin campus.  However, with Vetri’s acquisition, the company plans to expand into the casual dining sector, as the management feels that consumer spending has shifted from apparel and cosmetics to food, particularly-casual dining. While it is still unclear how the company wants to operate Vetri restaurants, it acknowledges that Pizzeria Vetri concept has tremendous scope for expansion. Neither does Urban Outfitters have any synergies with the restaurant business, nor does it have any expertise in the area. And this is why investors feel that the acquisition of Vetri would stretch the company’s financial position and weaken the management’s focus towards its apparel business.

However, we believe that even though a restaurant acquisition appears unorthodox, it can help Urban Outfitters in some ways. It is almost certain that the company will not operate the restaurant business as a separate entity and will leverage existing Vetri outlets to promote and sell its merchandise, which could help improve brand visibility and bolster revenue growth. Urban Outfitters could have done the same by acquiring a smaller apparel retailer, similar to what American Eagle Outfitters (NYSE:AEO) did earlier this month, but a successful restaurant like Vetri could ensure higher foot traffic than an apparel retailer. Pizzeria concept is gaining popularity in the restaurant industry and Pizzeria Vetri was named the best pizza restaurant in America by the Food and Wine magazine. The same magazine also also named the founding chef, Marc Vetri, among the top ten new chefs. Therefore, it makes sense for Urban Outfitters to expand this small food chain, to benefit directly from the restaurant revenues and indirectly from cross selling.

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Notes:
  1. URBN to Acquire The Vetri Family of Restaurants, Urban Outfitters, Nov 16 2015 []
  2. URBN Reports Record Q3 Sales, Urban Outfitters, Nov 16 2015 []