Retailer Urban Outfitters (NASDAQ:URBN) was supposed to have an awful first quarter. After all, amid physical store closures and widespread stay-at-home orders, there really was no way the company was going to see growth in early 2020. That’s why URBN stock dropped from $29 in late February, to below $20 by late May.
Then Urban Outfitters reported first quarter earnings on May 19. The numbers were much worse than anyone expected.
Net sales in February, March, and April dropped 32%, paced by a 28% drop in comparable sales. The gross margin rate fell to a measly 2% (from 31% in the year ago quarter), and gross profits plunged 96% year-over-year. Worse yet, operating expenses fell by “only” 8%, so Urban Outfitters experienced significant opex deleverage. The expense rate ballooned from 27% a year ago, to 36%.
Ultimately, what was a small profit a year ago, turned into a wide loss of greater than $100 million this quarter.
URBN stock plunged on the bad news by about 10%, to essentially match its lowest levels of the decade.
Now, I think it’s time to buy the dip. Here are three big reasons why:
- Urban’s traffic trends are already improving. Amid broader economic reopening measures, these traffic trends will continue to rebound over the next few months.
- Unlike many of its mall retail peers, Urban Outfitters is a strong retailer, with a differentiated product assortment, high brand equity, and enough firepower to withstand the “Retail Apocalypse.”
- Urban Outfitters stock is significantly undervalued at current levels.
Improving Traffic Trends
Urban Outfitters’ first quarter earnings report was a disaster. But there was one glimmer of hope that emerged from the conference call: traffic trends are improving.
About 40% of Urban’s stores are now re-open. When they first re-opened, store comparable sales growth was trending in the down 80% range. Each week since then, traffic trends have improved. Now, that number stands around down 60%.
Sure, down 60% is still a huge drop. But in the EU, where economic reopening measures are further along than in the U.S., Urban’s sales are trending down in the 30% range. There’s no reason that U.S. and total company sales trends can’t get to that down 30% range within the next few weeks as more states push forward with reopening.
In other words, there is clear visibility for Urban’s comparable sales trend to improve from down 80% a few weeks ago, to down 30% over the next few weeks.
Such improvements will persist for the balance of the year. It increasingly appears that the worst of the coronavirus pandemic is over, and that countries across the globe are committed to reopening their economies. As this reopening wave sweeps across the globe — and as more time pass and consumers regain their confidence (and jobs) — Urban’s sales trends will continue to tick higher towards the flat-line.
A Strong Retailer
Unlike many of its mall retail peers which look doomed for the retail graveyard thanks to e-commerce disruption led by Amazon (NASDAQ:AMZN), Urban Outfitters is a strong retailer, with a differentiated product assortment, strong brand equity, and enough enduring value to grow sales and profits over the next few years.
Urban Outfitters isn’t a retail reseller. Most of the clothes they sell are branded clothes, i.e. they make and sell their own Urban Outfitters shirts and Free People dresses. These branded clothing lines give Urban Outfitters a solid product moat against the e-commerce wave.
So long as demand for the brand’s clothing lines remain robust, Urban Outfitters will keep selling a ton of product, regardless of how good Amazon gets at selling apparel.
Importantly, demand for Urban clothes has been and still is robust. Sales have risen by more than 15% over the past four years — an impressive mark for a mall retailer. Meanwhile, according to Piper Jaffray’s Taking Stocks with Teens survey, Urban Outfitters is the third most popular shopping website among young shoppers, behind only Amazon and Nike (NYSE:NKE).
Big picture: Urban Outfitters isn’t your average mall retailer. This company is the cream-of-the-crop in the mall retail world. It’s not headed for the retail graveyard. Instead, the company is positioned for steady and solid growth over the next few years.
URBN Stock Is Undervalued
If Urban Outfitters can grow revenues and profits at a steady pace over the next few years, then URBN stock is way undervalued today.
Based on assumptions for low single-digit revenue growth and mild profit margin expansion, my modeling suggests that Urban Outfitters could report $2 in earnings per share by 2025.
Over the past five years, the market’s forward earnings multiple has averaged around 17. Based on that average multiple and a 10% annual discount, $2 in 2025 earnings per share implies a 2020 price target for URBN stock of roughly $23.
As of this writing, shares trade hands around $16. Thus, my modeling suggests 40%-plus upside over the next several months.
Bottom Line on URBN Stock
Urban Outfitters is being treated like just another depressed mall retailer. But this isn’t your average mall retailer. Urban Outfitters is a differentiated retailer, which has the potential to grow both sales and profits over the next several years.
If so, then URBN stock is way undervalued today.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he was long AMZN.