Devil’s Advocate Short List: Urban Outfitters (URBN)

If the markets revert to selling pressures again and add to losses from last week, the high-flying retailers are a group that could see increased selling pressure and short interest.   The apparel industry averages right now are about what we would expect, with trailing P/E’s around 19-20, P/S between 0.8 and 1.0, and operating margins between 7% and 10%.  Most companies in this space, especially the younger ones, are running on record earnings and peak margins.  This doesn’t mean that companies who are growing their sales and their margins will automatically stop if the economy or consumer spending “takes a breather.”  But any time a retailer miscalculates inventories or miscalculates on the demand (brand popularity) margin gains will be eroded or go the other way. 

There are already various levels of concern for consumer spending ranging from mild to major.  In an environment like this, companies with the highest relative valuations to their peers need to really shoot the lights out of their comps and margins to avoid being brought back down to industry norms. 

A devil’s advocate review on Urban Outfitters (URBN) reveals what could be a short-sale highlight film given the right conditions, and with earnings due out Thursday (for fiscal year ending 01/31/07), this is a good time to evaluate the company ahead of earnings.  We should simultaneously get the February same-store-sales and some sort of preliminary guidance for the coming quarter.

URBN stock currently trades for 27x forward earnings (36x trailing) and over 3x sales.  The company earned this premium by having double-digit level comps and a strong wholesale business for the past few years.  But comps have been showing weakness, with 4th qtr. same-store sales down 5% versus an 8% gain the year before.  The wholesale segment’s sales growth remained strong, but that won’t be enough to support the stock without improving its comps.  The retail channels still supply well over 75% of total revenue.

Analysts haven’t made any major changes to estimates since the beginning of the year.  Current estimates call for 18% revenue growth and 25%+ net income growth, both very lofty targets that could soon prove difficult with one or two more bad months of comps.

Keep in mind that this stock was a split-adjusted 2 bucks per share back in the spring of 2003, giving shareholders a nearly 800% return in four years.  It’s now a $4 billion cap company, which is a heavyweight in the apparel space.  Urban Outfitters is also closely held and has an already-sizeable 7% short position (as of mid-February).   At $24.85 Urban Outfitters has also managed to climb back up well off of the $13.65 to $15.00 lows and much closer to the $27.00 highs over the last 52-weeks.  This is more on hopes than it has been on raw performance in its stores.  In late 2005 this traded north of $30.00, so it has already seen one fall from grace for the retail trend investor.

It has managed to pull some misses in its retail offerings compared to its barnstorming homerun lineup it enjoyed for more than 3 years. The devil’s advocate would say that all of the conditions are there for some rain to return to return, as this stock could very easily fall down to industry-level valuations should they continue to underperform on their comps OR if consumer spending weakens.

We are still screening other names and sectors that we’ll be publishing in the coming days.  If further signs of weakness occur in the broad markets occur, having three or four “At Risk” names ready to go would be a good strategy, just to appease the devil’s advocate in all of us. 

Written by Ryan Barnes, edited by Jon C. Ogg
March 6, 2007

Jon Ogg can be reached at [email protected]; he does not own securities in the companies he covers.