Urban Outfitters' Slow-Moving Problem

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Last night, Urban Outfitters (NAS: URBN) reported better-than-expected quarterly earnings. Second-quarter revenue came in at a record $609.2 million, an increase of 10% compared to last year. The company's diluted earnings per share reached $0.35, a drop from last year's $0.42.

Overall comparable-store sales fell by 2% for the quarter, while the company's Free People comps held strong at 18%. Comps at the company's flagship Urban Outfitters channels and Anthropologie stores were 1% and flat, respectively.

You may have noticed that revenue rose while earnings fell. This partially owes to a big drop in the company's gross margin, which plummeted from 42.5% last year to 37.9%. The company attributed this decline to markdowns necessary to clear slow-moving inventory at Urban Outfitters and Anthropologie, in addition to occupancy deleveraging caused by those falling same-store sales. Sounds oddly familiar, doesn't it?

Such a precipitous drop in gross margin is somewhat ominous. While revenue rose 10%, Urban Outfitters' cost of sales rose 19%. The company's inventory balance has also swelled by 24.6% over the past year. This wouldn't particularly concern me if the company were bracing for higher demand, but I'd be cautious in the context of the company's "slow moving" apparel inventory. If the company continues to face weak demand, this inventory may also need to be marked down in the future in order to finally leave shelves.

I think there are more promising places to invest in retail apparel -- namely, in companies that can move their inventory. Retail competitors Fossil (NAS: FOSL) and Guess? (NYS: GES) come to mind. Fossil recently reported a strong quarter, with revenue jumping 35%. Likewise, Guess? has been putting up some healthy numbers of its own.

Retail stocks are bound to perform nicely as the economy recovers, albeit with some bumps along the way. It's not that I don't like Urban Outfitters. I just like other retailers' prospects even more.

At the time this article was published Fool contributorEvan Niu's wife frequents Anthropologie and loves when they mark down inventory, but he holds no position in any company mentioned.Click hereto see his holdings and a short bio. The Motley Fool owns shares of Guess and Fossil.Motley Fool newsletter serviceshave recommended buying shares of Fossil and creating a modified stock repair position in Guess. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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