Why This Company's "Bad Earnings Report" Was Really Good

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When Urban Outfitters (NASDAQ: URBN) released its earnings numbers for the third quarter on November 19, there was a rush of bears that sent the stock down nearly 10% within seconds. Urban missed analysts’ earnings expectations by a penny per share, and same-store sales were down 1% year-over-year. This headline caused institutional investors to sell now, and try and figure out why they were selling later.

Had those investors waited around for the conference call, they might have realized that despite missing estimates on the bottom line, the company is growing quite nicely. At the beginning of the year, co-founder and CEO Dick Hayne retook the reigns of Urban Outfitters and outlined several goals for the company, all focused on the end result of growing the top and bottom line. Here’s how the company has done so far.

Productivity

This goal has two parts: First, Hayne wanted to produce better products that fly off the shelves at retail price. Second, he wanted to create more effective marketing campaigns. The company’s focused effort on these two things led to some fantastic results in the third quarter.

Regular-priced selling certainly accelerated in the last quarter. This is most obviously seen in Urban Outfitter’s need to markdown items, which fell by greater than 2% year-over-year. Consequently, gross margin improved by 220 basis points to 37.6% and operating margin improved 150 basis points to 13.5%.

While same-store sales declined 1% from the same period a year ago, it’s important to note the company actually grew total company comparable retail segment net sales by 8%. The difference is the latter includes Urban’s direct to consumer business, which grew 36% year-over-year. Moreover, each of the company’s retail segments – Urban Outfitters, Anthropologie, and Free People – increased total comparable sales. By way of comparison, Gap (NYSE: GPS) and its three brands, grew total company comparables just 6% in the last quarter.

In terms of marketing, the company definitely focused more on web, particularly mobile, users. Web-based marketing nearly doubled while catalog spending fell by 3%. The results were impressive: a 32% jump in total web traffic, sales from mobile devices tripled, and a 50% increase in sales coming from social media, all of which led to the 36% increase in direct to consumer sales.

The online market is becoming very competitive. Gap and Abercrombie & Fitch (NYSE: ANF) have also seen accelerated growth in online sales. Gap’s and Abercrombie & Fitch’s direct to consumer businesses increased revenue 23% and 25% respectively year-over-year last quarter. Consumers are buying more clothing online every day, and this is where Urban Outfitters is significantly outdoing the competition.

While Urban continues to grow its number of stores, with a goal of 200 to 250 in the U.S., I believe it' increasing online presence provides the greatest upside for the company and its investors. Online sales generally provide higher operating margin as there are fewer SGA expenses, and are therefore more profitable. However, the company needs to improve its return rate from online sales. Returns at local stores from direct to consumer purchases, which count against store sales, brought same store sales growth into the negative.

New Channels & New Customers

New channels and new customers refers to expanding the company abroad, as well as reaching more consumers with its current stores and online presence. I refer you to the previous segment for information on same-store sales and the company’s online business. Here, I’ll mostly talk about the company’s international progress, new stores, and distribution.

Urban Outfitters only recently started expanding abroad. Last quarter, the company opened three new Urban stores in Germany. Additionally, the company saw an 88% increase in demand on its German website. Comparatively, urbanoutfitters.com saw a still impressive 25% increase in sales.

The company’s other brands, Free People and Anthropologie, are also making progress in global expansion. Free People signed a deal with World Inc. to distribute Free People wholesale products in Japan. The company also opened its first two Free People stores in Canada last quarter. Meanwhile, Anthropologie opened four new stores in the U.S. and overhauled its website to attract more sales.

One of the company’s greatest successes last quarter was the pick, pack, and ship initiative. Through this program, Urban Outfitters is able to fill online orders through store inventories. During the third quarter, $23 million of direct to consumer sales were filled through store inventories. Without the initiative, the company estimates that half of those sales would have been lost due to the products being out-of-stock.

Currently, the company generates just 15% of revenues from abroad and 24% of revenues from its direct-to-consumer business. Hayne wants both of these numbers to improve. He’s said in the past that he hopes Urban Outfitters can drive 50% of its sales through its website. Additionally, he plans to open 100 stores for both Urban Outfitters and Antrhopologie in Europe. The company doesn’t have a lot of presence in Asia yet -- another opportunity for great growth. I believe this is the best way for the company to grow profits. Establishing an international and online presence will make the company’s products accessible to nearly everyone.

Expand Product Offering

In terms of expanded product offering, the company made the most progress with web-exclusive products. Web-exclusive products accounted for 37% of online sales in the last quarter, nearly twice as much as the same period a year ago. This focus on web-exclusives is intentional to drive online sales to that 50% goal Hayne has in mind. Urban Outfitters expanded its in-store product selection as well. Anthropologie began selling petite sizes and yoga apparel this year, and you can buy intimate apparel Free People.

What It All Means

To put it simply, the company is executing its growth plan. The top line continues to improve and the company is focused on margins, and with that the earnings will fall into place. Next quarter, the company plans on being “less promotional.” In other words, it plans on fewer markdowns, thus improving margins further.

While Urban did not meet its fourth goal, to develop or acquire a new concept, that’s not as important as increasing its margins and expanding its international and online presence. The company knows how to build successful brands that resonate with their customers’ lifestyles. A new brand will surely come in time, as that’s one of Urban Outfitters’ strengths.

I believe this growth strategy will work for the company. Its focus on direct to consumer sales will improve margins across the board, and international expansion will help the company reach new customers. After earnings took the stock price lower, you’re essentially getting this last quarter for free.


adamlevy has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Gap. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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