Specialty Retailer Makes Risky Expansion Push

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Urban Outfitters (NASDAQ: URBN) has improved its inventory, made significant progress with online and mobile marketing, and it’s planning an aggressive expansion. The company’s first-quarter sales also increased 14% to approximately $648.2 million, mostly driven by its impressive direct-to-consumer performance. Same-store sales grew 6% for Urban Outfitters, 8% for Anthropologie, and 44% for Free People. 

While everything about Urban Outfitters looks good right now, that doesn’t mean a strong future is guaranteed; nor does it mean that it’s the best investment option in the space. For instance, Gap (NYSE: GPS) has made an impressive turnaround of its own -- more on this below. And then there’s Abercrombie & Fitch (NYSE: ANF), which had always been a big player until recently.

We’ll take a quick look at all three companies and then determine which one, or two, are likely to offer the best returns moving forward.

Urban Outfitters' expansion

Prior to getting to the company’s expansion news, it’s important to understand the different stores and their target markets. Urban Outfitters targets the 18-to-28 year-old crowd, which doesn’t make it a teen retailer. There's a slight overlap with teens, but covering a 10-year age demographic offers a lot of opportunity. Teens always wants to be one step ahead of the crowd, which means they are also likely to shop at Urban Outfitters -- to look one step cooler.

Anthropologie targets the 18-to-45 year-old female crowd; Free People targets the 25-to-30 year-old female crowd; Terrain sells home and garden products, antiques, plants and flowers, and wellness products; and BHLDN is the place to go if you’re getting married and looking for a wedding dress or other wedding-related products.

In the first quarter, Urban Outfitters opened five stores in the United States -- two Anthropologie stores and three Free People stores. It also opened two international Urban Outfitter stores -- one in Canada and one in Europe. In 2014, Urban Outfitters plans to open 35 to 40 new stores -- 14 in the United States and 25 internationally. The store breakdown: 16 Urban Outfitters, 14 Free People, and 9 Anthropologie.

You can look at this expansion in two different ways. If you’re taking a bullish angle, then expansion is almost always a sign of strength. It indicates that the company feels confident in its fiscal position and future prospects. If you’re taking a bearish angle, then Urban Outfitters might have put itself in a dangerous position if the economy heads south and consumer sentiment weakens. Also, if two locations are within close proximity to one another, then Urban Outfitters could see weakened margins. 

Competition

Gap has aggressive expansion plans as well, especially in Latin America. Gap should feel good about itself considering its turnaround and recent performance -- same-store sales have improved year-over-year for every month so far in 2013 except March. Gap has been controlling expenses well, and it also plans on stealing market share from Lululemon by opening new stores near Lululemon stores, selling its Athleta brand, and undercutting Lululemon prices.

Approximately seven years ago, Abercrombie & Fitch CEO Mike Jeffries stated that Abercrombie & Fitch goes after the cool kids, that a lot of people didn’t belong, and that they couldn’t belong. Though old news, social media wasn’t as popular seven years ago. Once this story resurfaced, it exploded on social media, which then led to a decline in Abercrombie & Fitch’s brand popularity.

This news seems to have negatively impacted performance: same-store sales declined 13% at Abercrombie stores and 18% at Hollister-brand stores year-over-year. According to Alexa.com, page views per user at Abercrombie.com have also declined 10.1% over the past three months. The stock is trading at 15 times earnings versus an industry average of 17 times earnings, and the balance sheet is strong, but revenue and earnings have recently slipped. 

Piper Jaffray surveyed 5,200 teens, and Abercrombie & Fitch’s Hollister brand ranked number one for brands that males no longer wear. Abercrombie & Fitch ranked second for brands that females no longer wear. 

Conclusion

Abercrombie & Fitch would be the riskiest investment at this time. Urban Outfitters and Gap both present decent investment opportunities, but with the global economy on edge and the consumer lacking sustainable confidence, these would also be risky investments. 

Urban Outfitters is trading at 24 times earnings, whereas Gap is trading at 16 times earnings, which makes Gap a better value. Furthermore, Urban Outfitters doesn’t pay any dividends, whereas Gap currently yields 1.5%. Finally, Gap is likely to be more resilient in difficult market environments due to its size and brand/geographic diversification.  

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