Urban Outfitters Is Dressed to Party

The trendy clothing and home furnishing retailer plans a big expansion into malls, which could help keep its hot stock rockin'

By Amy Tsao

Few alternatives exist for shoppers who have tired of the preppy sameness of chains like Abercrombie & Fitch (ANF ) and American Eagle (AEOS ). But the dare-to-be-different crowd has recently discovered eclectic up-and-coming retailer Urban Outfitters (URBN ). Its customers "don't want to buy something that someone else is wearing," says Noel Goeddel, portfolio manager at Holt-Smith & Yates in Madison, Wis. So they've gravitated to Urban Outfitters' broad and unusual mix of clothes, accessories, and home paraphernalia -- in-house brands as well as those by popular designers. (Goeddel owns the stock, and so does his firm.)

The retailer seems to have found a winning strategy in catering to the tastes of post-adolescent spenders -- typically fashion-savvy 18- to 30-year-olds -- and wants to go to the next level of becoming as well-known and as easy-to-find at malls as Gap (GPS ), analysts say. The outlook is promising.


  The Urban Outfitters chain of 61 stores already sells a mix of housewares and hip clothing that appeal to the "upscale homeless," says Chief Financial Officer John Keyees, referring to its target buyers of college kids and recent grads. They often live in apartments and set aside a big chunk of change for clothing. Urban Outfitters' newer (and pricier) Anthropologie chain of 52 stores serves the "35-year old, affluent woman," he says. "She's mated and probably has kids."

Sales at the Philadelphia-based Urban Outfitters have soared -- up 50% in the fiscal fourth quarter ended Jan. 31 -- as more people discover its trendy, yet quirky merchandise. It reported $48.4 million in net income on $548.3 million in sales for fiscal 2004. Investors are pleased. The stock has been breaking record highs for the past two years, rising 200% from $15 to a closing price of $46.89 on Apr. 19.

Better yet, the chain says its concepts are in the early stages of expansion, and a few analysts believe this stock could deliver stellar results over the long term. "Quadrupling [the size of the company] is absolutely achievable," Keyees says. Within five years, Urban Outfitters figures it can have a total of 175 to 200 of its namesake shops and 200 to 250 Anthropologie stores -- up from a total of 113 stores (including both chains) today.


  CFO Keyees says he expects higher earnings to come primarily from new-store growth. The retailer has a history of posting 20% average annual revenue growth, helped by 6% same-store sales gains. "If we grow at 20% on the top line, we expect the bottom line to be somewhat better than that rate," Keyees says.

Urban Outfitters could grow at a faster pace than almost any other player in this sector in the next three to five years, experts say. Like many before it, Urban Outfitters has taken a portfolio approach. So far, it seems to be working. Its Anthropologie concept has proven to be a hit, and Wall Street is excited about a potential third chain, based on its Free People line of clothes. In fact, Urban Outfitters is looking a lot like a young Gap, which runs Banana Republic and Old Navy, or Limited (LTD ), operator of the Victoria's Secret and Express chains.

Goeddel says he was waiting for the market cap on Urban Outfitter stock to come up for months. He finally bought the stock about a month ago. "I was a little leery chasing it. But seeing what its future holds, we were comfortable with the valuation." He figures the current forward price-earnings valuation of 29 times fiscal 2005 earnings could rise to around the low- to mid-30s.


  Goeddel expects earnings growth over the long term to hit an impressive 25% a year. He figures a fifth of revenue growth will come from adding new stores alone. As the concepts catch on with more people, existing stores will be more productive, adding another few percentage points in growth. Direct sales (via the Web and catalog), up 110% in the fourth quarter, should be another incremental boost to earnings.

As it expands, Urban Outfitters should be able to improve profit margins. As it increases in size, it has ordered in higher volumes and become a viable buyer to its suppliers. The increasing credibility has allowed it to demand better terms on merchandise. In fiscal 2004, the chain had a 14.7% operating margin. Keyees says he aims to get that number above 17% in the next three years.

Technology investments should also boost margins. A system designed to plan and allocate merchandise should be in place by this fall and will reduce markdowns. "Benefits of that will be seen the first part of next year," Keyees says. Urban Outfitters is also rolling out product-tracking systems and software to manage new-store construction.


  A key factor in its growth is the move into malls. So far, Urban Outfittlers has opened stand-alone stores mainly in busy cities or college towns -- away from suburban malls. But much of the new growth for both concepts will be mall-based or in so-called lifestyle centers.

"Malls lend themselves to a more formulaic approach," says Dave Turner, analyst at BB&T Capital Markets, noting that the expansion process can be much more efficient, and setup costs are typically lower. Since top malls are owned by a handful of operators, "they can go to the 10 largest mall owners and work it out from there." (Turner doesn't own shares, and the firm has no banking relationship with Urban Outfitters.)

Yet as it works to become a multibrand, several-hundred-store retailer, Urban Outfitters will need to focus on keeping its reputation as a refuge from racks lined with the same-old khakis and sweater sets year in and year out. The move into typically suburban malls runs the risk of "diminishing uniqueness," says Turner. Being able to draw traffic without cookie-cutter brands is one of its strengths and something it will want to be careful to preserve as it expands. "There's a concern that we could become too common," Keyees admits. "You have to be a little sensitive to that."


  As for the stock, a lot of the growth and margin improvements could already be factored into its price, Turner says. "Shares have been trading well above historical and peer-group averages," he notes, and Urban Outfitters is up against tough sales comparisons this year as well as a gradually slowing earnings growth rate. Turner is a fan of Urban Outfitters for the long term but recommends that new investors wait for a 15% pullback in the stock, to $40, before buying.

Considering that retailers have done much better than expected so far this year, a drop in the sector could come at anytime, analysts say. When it does, this stock, while expensive, might be a welcome addition for investors who want a hot-growth retailer in their portfolio for the next few years.

Tsao covers the markets for BusinessWeek Online and writes for the Street Wise column

Edited by Beth Belton

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