Heading into the Urban Outfitters, Inc. (NASDAQ:URBN) fourth-quarter earnings report, there were two areas of focus for investors. Urban Outfitters already released Q4 sales figures in early February. Flat comparable-store sales for the period were below expectations, but URBN stock still gained modestly on the news. As such, trailing revenue wasn’t likely to be a major point of emphasis in the Urban Outfitters earnings report.
Rather, the focus was on margins, and on fiscal 2018 (ending January) guidance. And on both fronts, expectations were low. MKM Partners downgraded URBN stock on Feb. 27, specifically citing margin pressure at Anthropologie. Wunderlich cut its price target for URBN to $26 on Monday, projecting compressed margins from higher online sales. Goldman Sachs already had cut Urban Outfitters stock to “Sell” in early February, on concerns of overall retail weakness going forward.
Urban Outfitters earnings for Q4 appear to support those concerns — even though shares have risen modestly in after-hours trading.
The same pressures dogging the entire retail sector appear to have made their way to Urban Outfitters. That’s not pushing URBN stock lower in Tuesday after-market trading, but it could in the weeks ahead.
Urban Outfitters Earnings Show Margin Pressure
Many retailers have responded to the endless omnichannel threat driven by Amazon.com, Inc. (NASDAQ:AMZN) by building out e-commerce businesses of their own. But until recently, investors hadn’t quite understood the inherent problem with that strategy: It hurts profit margins.
Adding an e-commerce supply chain and other capabilities on top of an existing brick-and-mortar footprint simply adds more cost. And to compete with online-only rivals, retailers must cut price as well.
Urban Outfitters specifically cited that problem in its Q4 release. Gross profit margin for the fourth quarter was down 142 bps year-over-year. The issue, per URBN, was “primarily” delivery and supply chain costs. Those costs were elevated by increasing DTC (direct to consumer sales). For the quarter, flat comparables were driven by a double-digit increase in DTC revenue – offset by declining sales in-store.
The formula of ~flat revenue and increasing e-commerce share implies margin and profit pressure – and that’s exactly what happened to Urban Outfitters earnings. Net income declined 12% year-over-year in Q4, with EPS missing analyst estimates by a penny. And declining profits won’t support URBN stock, which still trades at nearly 14x EPS at after-hour prices. (To be fair, the multiple is closer to 12x including the company’s ~$3 per share in cash and securities.)
Sales and Profit Growth Questions Remain For URBN Stock
The problem coming out of the fourth-quarter release is that those margin pressures aren’t likely to abate. In fact, CEO Richard Hayne said in the Q4 release that Urban Outfitters would increase its focus on DTC sales. Store occupancy costs were flat as a percentage of sales in the fourth quarter. But further revenue weakness in store could add deleverage on that line as well — and further pressure Urban Outfitters earnings.
From a sales standpoint, there wasn’t much new information in the release, though the post-earnings conference should give more color. It does appear that the Urban Outfitters brand, which accounted for 40% of FY17 sales, is reasonably well-positioned. That brand did have higher markdowns in Q4 — but lower discounting on a full-year basis.
The other 60% or so of the retail base, however, may have some concerns.
Anthropologie sales declined in Q4, as mentioned, even with higher markdowns. And Free People saw lower gross margin in FY17 – again, due to higher markdowns.
URBN Stock Isn’t That Cheap
All told, there’s enough in the Urban Outfitters earnings release to suggest some potential problems for URBN stock in 2017.
It’s not as if Urban Outfitters is all that cheap, either. A 12x-plus cash multiple might sound inexpensive, but it’s in line with most of the retail space. Gap Inc (NYSE:GPS) trades at similar levels, as does American Eagle Outfitters (NYSE:AEO). Both of those stocks are coming off decent years — in my opinion, better years than Urban Outfitters. AEO, in particular, given its ownership of Aerie, has a growth catalyst that URBN stock may not at the moment.
Retail in general is an extremely tough space, to the point that some observers have called the sector simply “uninvestable.” I tend to agree with that characterization. Those investors looking to enter the space need to chose only the best companies, with the least risk. Urban Outfitters is one of the better companies, but I’m not sure it’s quite top-tier.
And coming out of Q4, there are a lot of potential risks to both sales and margins in fiscal 2018.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
