Why Urban Outfitters Is More than Fashionable

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Outside of the world of investing, urban sprawl can be a nuisance because of the traffic it creates and the difficulty it poses for public transportation systems. In the case of the trendy retailer Urban Outfitters , a $200 million expansion of the company's headquarters and construction of a distribution center is music to an investor's ears.  However, the market was not impressed with the retailer's most recent earnings report. Since this latest release, the company's shares have been hammered because of poor outlook in the teen retail industry. A deeper dive points to this growing company climbing its way back to the top, though.

A vast terrain
I don't frequent the teen stores in the malls anymore, but I try to stay aware of brands that frequent the retail world. The flagship store carries the company name in every major city and Anthropologie has a space in numerous malls, but I only just recently became aware of Anthropologie's sister brand, BHLDN, which specializes in wedding attire. The bridal brand, along with company pioneer Free People and home-and-garden newcomer Terrain account for almost 5% of the company's revenue. It may not be a heavy load, but these small brands give Urban Outfitters an edge over competitors, particularly because many consumers have yet to see these stores.

Revenue per square foot is huge in the clothing industry; making the most out of every bit of space drives margins ahead of others with underused space. Through 2012, revenue per square foot in the division comprised of BHLDN, Free People, and Terrian has rocketed to $1,025. To get a better perspective, consider that American Eagle Outfitters brand for teen girls, Aerie, came in at just $279 for the same year. The success of Urban's minor divisions will help offset the slower rate for the company's larger brands. 

Fighting the other popular kids
Styles change at least every season, and sometimes the teen leader can be dethroned just as often. Urban protects itself against this kind of risk by targeting adults up to age 45, turning over its products quickly, and keeping markdowns low. The 47.9 million catalogs issued during Urban's fiscal 2012 help bring the brand to people who live far from a retail location.  This type of marketing results in direct-to-consumer sales and requires lower costs than television advertisements. Logos that fill middle schools and have history on their side are less scrutinized, but a look at all-important free cash flow may surprise some shoppers.

URBN Free Cash Flow TTM Chart

URBN Free Cash Flow TTM data by YCharts.

American Eagle Outfitters boasts large, efficient stores and has managed an overall revenue per square foot of $514. However, larger stores often require more employees and face higher operating costs such as store rent in shopping malls. Revenue will have to increase more dramatically to hike this metric and earn analyst approval, but doing so will prove difficult because of a smaller target market. American Eagle focuses on younger consumers and markets mostly clothing and footwear, whereas Urban has specialized stores and a broader target audience that will help cash flow stay strong during the holiday surge. American Eagle reported fourth quarter sales growth of just 5% last January. It would need record results to one-up Urban's sales increase of 15% during last year's final two months. Anything near that pace will push holiday sales over $1 billion in just over two years for Urban Outfitters. 

Catalog competition
The holiday season brings store catalogs to mail boxes, and although Urban was strong in this category last year, it faces a formidable, time-tested opponent in Abercrombie & Fitch . The century-old apparel machine has increased revenues from Internet and catalog orders 34% every year since 2010, armed with the namesake stores as well as Hollister and Gilly Hicks. Cash flow isn't far behind Urban, and Abercrombie's success with both male and female consumers will allow it to keep the gap small. 

As in many sectors, international expansion is the source of a ton of upside. Abercrombie looks to expand its brands into valuable markets such as Russia, but the weak international economy could hinder this goal. Urban's similar goals included 15 global store openings in 2013, but more importantly, growth of global e-commerce. Japan is rumored to be getting its online dose of Urban later this year. Abercrombie may have four times more "likes" on Facebook than Urban, but tapping the Internet in foreign markets will help Urban take its $662 million in Internet and catalog orders in 2012 to new heights.

And they're off!
Shoppers were out and about at my local mall and many stores had holiday offerings in full force. I walked by the three stores discussed here. I didn't expect to actually browse in any of them, but I got lured into Urban Outfitters by books and vinyl records. This type of diversification will allow Urban push its operating margin well beyond the current 15% leave its competitors playing catch-up.

No Pitch

The article Why Urban Outfitters Is More than Fashionable originally appeared on Fool.com.

Kyle Vaughan has no position in any stocks mentioned. The Motley Fool recommends Urban Outfitters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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