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Urban Outfitters, Inc. (URBN): When Quirky Hipsters Crush the Preppies

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Shares of niche apparel retailer Urban Outfitters, Inc. (NASDAQ:URBN) rallied recently, after the company announced that it was on track to report a strong first quarter of 2013, allaying concerns regarding the Philadelphia-based company’s mixed fourth quarter earnings.

Urban Outfitters, Inc. (NASDAQ:URBN)

Urban Outfitters, Inc. (NASDAQ:URBN) has had a great year, soaring 36% over the past twelve months, while many other apparel retailers have slumped. What are Urban Outfitters’ primary catalysts for growth, and can it keep riding the rising trend?

Fourth Quarter

For its fourth quarter, Urban Outfitters earned an adjusted $0.56 per share, or $83 million, up 107.4% from the prior year quarter. Despite the positive growth, earnings per share missed analyst consensus by a penny. Revenue rose 17.29% to $857 million and topped the consensus estimate of $848.24 million.

Sales Growth

All of Urban Outfitters, Inc. (NASDAQ:URBN)’ three primary brands – its namesake stores, Free People, and Anthropologie – posted positive comparable retail segment sales growth during the quarter for a company average of 11%. Its important to note that comparable retail segment sales and comparable-store (same-store) sales are not the same thing. Comparable retail segment sales, which the company has emphasized, combines regular same-store sales with direct-to-consumer sales, which also include online purchases.

Under this metric, Urban Outfitters’ namesake stores, which offer kitschy, ironic and humorous apparel and merchandise, reported 11% growth. The stores are best known for catering to “hipster” fashion, which draws heavily from retro influences, such as classic video games and cartoon characters. Meanwhile, Anthropologie, its trendier female brand, which also sells gifts and beauty products, grew by 7%. Free People, which caters to a younger female demographic, reported 37% growth.

While all that growth sounds robust, Urban Outfitters, Inc. (NASDAQ:URBN) announced that its company-wide same-store sales were flat from the prior year. What happened? Although direct-to-consumer sales rose 44%, same-store sales flatlined due to increased returns of direct-to-consumer products at brick-and-mortar locations, which reduced total same-store sales. In other words, people returned so much stuff that it was unable to grow its mature stores at all. CFO Francis Conforti noted that total same-store sales would have been positive if it weren’t for direct-to-consumer returns at stores. Worse yet, a 2% increase in transactions was completely offset by a 2% decline in average unit price.

Slowing growth, lower prices and more returns certainly sound hazardous for Urban Outfitters, but should longer term investors be concerned? At this point, investors should study the company’s revenue growth, inventory levels and margins for signs of weakness.

Right away we can see that Urban Outfitters, Inc. (NASDAQ:URBN)’ revenue and inventories are steadily rising in a cyclical trend. Inventories tend to outpace revenue growth for most of the year, spiking near the holiday season before strong sales reduce the inventories to more stable levels. During the fourth quarter, inventories rose 13% to $282 million.

This means that Urban Outfitters, just like many other apparel retailers, relies heavily on a successful holiday season to keep growing. The company’s margins and profit growth tell a similar tale.

Look on the bright side

Although flat same-store sales have raised some concerns regarding Urban Outfitters’ growth prospects, the company opened ten new stores during the quarter, which drove a $19 million increase in non-comparable store sales. Its strong growth in the direct-to-consumer channel, which has also been a major growth driver for industry peers Abercrombie & Fitch Co. (NYSE:ANF) and The Gap Inc. (NYSE:GPS), is also extremely encouraging.

Urban Outfitters, Inc. (NASDAQ:URBN)’ increased growth in this channel was a direct result of heavier investments in fulfillment centers, technological advances, product offerings and the addition of new creative staff. This produced a better selection of seasonal products, a wider range of product categories, more creative catalog designs and web-exclusive products.

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