Urban Outfitters’ Weak Results Beat Expectations

Urban Outfitters’ (NASDAQ:URBN) shares shot up 20% on the release of its second quarter earnings on August 15th. While the stock of a retail company going up by 20% is a surprise in itself, what is even more astonishing is that the company’s results were actually quite weak. While URBN managed to beat consensus estimates on both revenues and earnings, its sales were down by 2%, and its earnings by over 33% per share. The comparable sales for the company declined by 4.9%, which is better than the 6.9% that was expected, but it is a bad fall, and the most in seven years. Comps in the Urban Outfitters brand were down a massive 7.9%, while that for Anthropologie were a negative 4%. Free People’s results were the only bright spot for the company, whose comps were up by 2.9%. However, this brand contributes a much smaller share of the revenues as compared to the other aforementioned brands.

Declining Margins A Cause For Worry

Urban’s gross profit margins declined by 440 basis points in the quarter, to 34.1%, as compared to the second quarter in FY 2016. The main reason for this has been cited to be the underperforming women’s apparel and accessories merchandise at Anthropologie and Urban Outfitters, which forced the company to undertake higher markdowns. Another factor responsible for it is the higher delivery and logistics expense related to the focus on the direct-to-consumer (DTC) channel. These factors together with the higher digital marketing spend resulted in the fall of the operating margin by 470 basis points, to under 9%.

In its prepared statement, the company did say that the gross margin is expected to decline at a lesser rate than that seen in the first half, and that August was faring better than the second quarter, with a slight improvement in traffic, and better reaction to the women’s line. This would imply better comps, and consequently a reduced need for markdowns. Whether this trend continues through the quarter remains to be seen. Moreover, the highly competitive nature of the apparel retail business makes the achievement of higher margins pretty unlikely. Since the merchandise is very similar across most retailers, they resort to reducing prices in order to gain market share, which has been wreaking havoc on the bottom-line for many such companies. Hence, while reduced markdowns may give some respite, the margins of retail companies can be expected to remain pressured for the foreseeable future. Moreover, a focus on the better performing segments of the company – DTC and Free People Wholesale – will no doubt have a positive impact on the top line, but it won’t do the bottom line any favors.

Urban Being Brought Down By Its Own Problems

Outside factors aren’t alone in causing the declining sales of the Urban brands. One-dimensional focus on separates, and on tomboy within separates, at the expense of a well-balanced, wider assortment resulted in a downfall for the Urban Outfitters brand. Furthermore, a higher lead time inhibited the company’s ability to quickly rectify its mistakes. For this reason, the North American business spent the quarter trying to re-architect its business. Instead of buying a bulk of its assortment earlier, it started buying a smaller quantity upfront, and then bought the remainder, with a faster turnaround, based on the sales. While some of the weakness in sales was a result of this shift in its operating style, it may bode well for the future. While the full implementation of this strategy may take some time to even out the flaws, it may already be showing results, with women’s regular price sales for the Q3 to-date showing encouraging results.

Even for the Anthropologie brand, the merchandise lacked its core aesthetic, with pattern and color lacking. URBN has been working to fix these mistakes as well. In the second quarter, the sales of the regular-priced items improved sequentially as the quarter wore on, and if this trajectory continues, the comps should improve. However, the potential reduction in markdowns may hamper the sales growth, but may help out the margins. The 3% growth seen in Free People is impressive given the current retail situation. Moreover, considering the prior year’s quarter included higher sales as a result of increased markdowns, the potential of the brand can be considered to be strong.

While the apparel market in the US continues to be challenging, if the steps undertaken by the company do result in an improvement in the assortment, the back half of the year may not be as bad as the first half. Furthermore, URBN has an enormous potential in the international market, where the company has been witnessing positive comps. Keeping that in mind, the Anthropologie brand signed a wholesale distribution agreement to sell its home products in John Lewis stores in the UK. The Urban brand has opened three new stores in Europe during the quarter. Additionally, the company intends to sign several international franchise and joint venture agreements over the next one or two years. These actions may help the company tide over the weaknesses in the domestic market.

See our complete analysis for Urban Outfitters

Have more questions about Urban Outfitters? See the links below:

• Urban Outfitters Is Winning Online, But Losing At Brick-And-Mortar
• Why Has Urban Outfitters’ Share Price Declined After Soaring For Most Of 2016?
• Does Urban Outfitters’ Strategy Of Opening New Stores Make Sense?

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