Urban Outfitters: No Longer the Sector Bargain

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After nearly doubling over the last 15 months, Urban Outfitters (NASDAQ: URBN) appears no bargain anymore. The stock continues to trade at all time highs after reporting strong sales numbers yet the rebound appears overdone.

The specialty retail company operates under the Anthropologie, BHLDN, Free People, Terrain, and Urban Outfitters brands with nearly 500 stores mostly in the United States and Canada. It reported record holiday sales for the two months ended in December sending the stock to new highs.

The company credits effective marketing efforts, the creative execution of all brands catalogs and website improvements in pushing sales up 15% over the last two months of 2011. The Free People brand saw the largest increase with 33% net sales growth.

Over stored

The general womens and teen retail sector became over stored in the 2000s leading to limited store expansion and consequently stock growth in the sector since the financial crisis. In addition, the further advancement of internet shopping has reduced the need for stores.

General competitor Abercrombie & Fitch (NYSE: ANF) has reduced store counts from a peak of 1,125 back in 2008 to only 1,067 currently. This general over store issue has led the sector to be more focused on improving margins and cash flows instead of expansion. It also requires investors to focus more on a company that can improve the efficiency of the existing revenue base instead of adding stores.

Besides Urban and Abercrombie, American Eagle (NYSE: AEO), and Aeropostale (NYSE: ARO) have large store bases built up in the 2000s growth phases. The interesting part is that these companies generally have strong balance sheets with net cash, small dividends, and decent cash flows.

The below table compares some of general ratios used to value stocks. The enterprise value/sales being a strong indication of value potential once a sector has peaked out.

<img src="/media/images/user_15227/screen-shot-2013-01-28-at-25022-pm_large.png" />

Is Abercrombie a better value?

As the table above highlights, Urban Outfitters now has a stretched valuation based on what investors get. The company does have a lower store base with the ability to add more stores, but it will quickly run into the upper limits of store totals. Remember that the Free People brand might have a limited store based, but the company already sells the products in 1,400 specialty retail stores.

Aeropostale has the cheapest valuation using the enterprise value compared to sales. The company has recently seen revenue decline and earnings aren’t expected to match the FY12 levels even by FY14. The company might become attractive if a turnaround becomes more definite.

Ambercrombie appears to have the revenue and margins headed in the right direction due to store consolidations over the last 5 years. If the company can continue the turnaround, it provides a compelling valuation trading below 1x the revenue run rate.

Stock valuation

After the large run up over the last year, Urban trades at over 2.3x sales and 20x forward earnings. Analysts forecast earnings growing at a rate of 17% over the next 5-years. The company should hit the $3 billion revenue base in this calendar year. Growth will be difficult to maintain at a fast clip, even though a company such as Gap is expected to reach $16 billion in annual sales. To reach that level, Urban will have to grow revenue by 500%. Is that possible these days in a highly competitive retail environment?

Conclusion

The stock that was extremely hot during the 2000s has recently turned operations around. It now trades at valuations suggesting the stock needs to take a breather while at the same time the company needs years of growth to match the size of Gap.

Other sector stocks appear to offer better value though it will ultimately depend on the ability of the individual companies to increase profits from existing store bases and grow internet sales. The stocks trade at extremely low enterprise values compared to sales levels. This scenario can provide great values if the concept is able to squeeze higher margins out of the existing revenue. Right now Abercrombie appears the best positioned for that after years of cutting stores.


Mark Holder and Stone Fox Capital, LLC have no positions in any stocks mentioned. The Motley Fool owns shares of Aeropostale. 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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