Did The Pendulum Swing Too Far?
Urban Outfitters (URBN) has been certainly one of my favorite recommendations in the retail space. The stock was beat right down to the mid-teens last summer, a price that is almost difficult to believe. Shares were obviously way too cheap after that but as it’s rallied since then, I cannot help but believe we’ve swung too far to the other direction in the mid-$40s. The company’s fundamentals have unquestionably improved but given the value of shares today, I’ve turned somewhat bearish on the stock. To be clear, I nevertheless like the overall story at Urban Outfitters, but investors must pay a steep price to be a part of it.
Another outstanding quarter
There is absolutely no doubt that Urban Outfitters’ fundamentals have become a lot more favorable in the past couple of quarters. The company that has been left for dead by traders last year has been resurrected and now, can seemingly do simply no wrong. The company’s Q2 report has been absolutely outstanding and highlights the particular progress that has been produced.
Source: Q2 earnings slides
Indeed, as this slide shows, anything that could move right in Q2 did, plus earnings nearly doubled as the result. Total sales were upward of 14% as comparable sales jumped 13%. Strength was broad-based because all three of the company’s reporting segments saw double-digit increases; Urban Outfitters increased 15%, Anthropologie was up 11% and Free People increased 17%. These amounts are huge and certainly justify some bullishness as I’m unaware of another apparel retailer with strength like this today.
However, I am going to caution two items on the company’s comparable product sales numbers from Q2. First, keep in mind that Urban Outfitters was struggling last year along with comparable sales and in Q2 of 2017, it produced a -5% consolidated number. That pales in comparison to the +13% we saw in this year’s Q2, but it isn’t because the company is putting comparable sales gains along with every other. Some of this shift is simply a reclamation of sales that had been lost last season.
Second, extrapolating gains such as this out there into the future is a fool’s errand given what I actually just said and the reality that keeping up the stress of double-digit comparable sales increases is nearly impossible for any kind of company. I’m not here in order to debate whether Urban Outfitters’ present assortment is working with customers or not, because it obviously is. However, I’m cautioning traders not to get too excited about a very hot comparable product sales print as this sort of thing is tremendously hard to replicate. In particular, keep in mind that in the coming year, the company is heading to be comparing to these types of outstanding numbers, making it actually more difficult to continue to keep creating positive comparables at all, not to mention enormous gains.
Margins were upward a bunch in Q2 because as operating profit went up from 8. 6% of income to 11. 8%, which will be a huge increase. Gains had been produced from a combination of major margins and lower SG&A costs, both which were directly associated to the increase in comparable product sales. Higher comparable sales leverage lower operating costs, like store work and back office support costs, and thus, boost operating margins. In addition, Urban Outfitters will be working through a more self-disciplined inventory management approach and we all saw the results in Q2; inventory was up just 3% despite a double-digit increase within sales. That should lead to lower markdown activity because it did in Q2 as we move forward and allow the company to keep the hard-won gross margin gains. Again, I’ll caution that even though these increases are spectacular, repeating them further down the road is going to be very difficult. The business will have to compete with its own success in 2019 and beyond even though I believe in their story, I do not believe the current share price is taking into accounts just how difficult this year’s rebound is going to make it for the company in order to favorably compare against its results in the coming quarters.
Is There Still Room For Growth In Urban Outfitters?
Urban Outfitters’ fundamentals really couldn’t look any much better today and while that’s excellent, it is also already shown within the share price. The stock is trading for 17. six times this year’s earnings, which usually is about where it provides traded over the long-term. However, the current valuation is the particular highest it has been within the past three years, therefore on a relative basis, the stock certainly discusses least fully costed here. The valuation hit the trough this past year that was unsustainable, but this huge rally provides sent shares to the stage where they no longer provide investors value.
I still believe Urban Outfitters can offer traders double-digit earnings growth in the particular near-term as it is constantly on the notice comparable sales increases, a little bit of margin expansion and a small tailwind from the buyback. But provided in which the stock is trading, value upside from here looks such as a tall order and because a result, I think traders should consider trimming exposure in order to the stock. This story will be a good one but don’t lose sight of the value and how much good information is already priced in. Indeed, I’m apparently not the only one that feels this way as the company’s own CEO apparently doesn’t own a single share any more; exactly how curious is that?
Disclosure: I/we do day trading and may take either buy or sell positions at any point in time.