Focus On DTC Improves Sales But Pressures Margins For Urban Outfitters

-18.92%
Downside
43.42
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35.20
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URBN: Urban Outfitters logo
URBN
Urban Outfitters

Urban Outfitters (NASDAQ:URBN) posted a solid third quarter, easily beating consensus expectations, which had estimated a pretty downbeat period. While in the second quarter, the company was able to surpass expectations, it reported a fall in its revenues and earnings per share. That wasn’t the case this time around, as the company posted record third quarter sales and an improvement in its EPS. This impressive performance was driven by positive comparable sales growth in all three divisions, solid growth in its Free People wholesale segment, and the continued strength of its digital sales. The company has also placed itself in a good position to build on its momentum heading into the highly significant holiday quarter. URBN also noted that so far in November, the total retail segment comps are running ahead of the Q3 rates, with sequential improvement in store traffic and in-store sales.

We have a $21 price estimate for Urban Outfitters, which is lower than the current market price.

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Omnichannel Investments Paying Off

As we had expected, a comparable sales recovery was delivered this time around, with the company’s attempt to re-architect its business showing results in the third quarter. The main factor driving this growth was the strong performance of its online sales, with the digital penetration increasing 400 basis points in the quarter, eclipsing the previous record high posted in Q4 2017 (quarter ended January 2017). The segment, which increased by double-digits, now accounts for over 50% of the retail segment sales. The momentum in the channel was a result of an improved digital marketing effectiveness, and a broader assortment.

Looking ahead, as the company enters the holiday season, it aims to improve the digital penetration even further. To achieve this, URBN is spending more digital marketing dollars for each of its brands. The goal of this strategy is not just an increase in the sales, but it also targets customer acquisition and retention.

Margin Pressure To Remain

A fall-out from the focus on the digital segment is the margin erosion, due to the increased expenses related to delivery and marketing, and significantly higher investments in technology. While these additional expenditures are needed to drive sales growth and improve its share, it has resulted in increased pressure on the margins. As the company grows its business, the margins will tend to improve. However, how long that takes is not clear.

In the meantime, the company needs to undertake other cost-saving measures to reduce additional margin pressure. One such step would be to reduce the markdowns, as sales of full-price items would obviously have higher margins. The greatest opportunity for this exists in the Anthropologie brand, followed by Urban Outfitters. A highly promotional environment has plagued many apparel retailers, making customers accustomed to discounted merchandise. With a steadier economy at present, many retailers are trying to push back from their discount-driven past. However, it may not be as easy, since the shoppers seem to be hooked on to the deals. Furthermore, the holiday period anyway tends to be more promotional. Hence, it may be tough for URBN to follow this in the fourth quarter. Nevertheless, it is imperative the company attempts to move away from its promotional stance.

Another initiative would be to improve the speed to market. To see the success of this strategy the company just has to look at fast-fashion brands such as H&M, Zara, and Uniqlo. These retailers are able to able to move styles from the runway to the stores within weeks, constantly evolving their assortment and keeping their products fresh. Historically, retailers placed their bets on fashion a year in advance, and since they marked their products higher, there was room for markdowns. However, now companies have realized that by cutting the time down to three to six months, they don’t need to price the items higher. Analysis conducted by John Thorbeck, chairman of Change Capital LLC, and Professor Warren H. Hausman of Stanford University shows that retailers can increase their profits by as much as 28% and market capitalization by up to 43% if they are able to reduce their lead times and respond faster to changing consumer demand. In the long term, American retailers will be unable to compete with fast-fashion retailers if they don’t address this issue.

See our complete analysis for Urban Outfitters

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Urban Outfitters
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