3 Keys to Urban Outfitters' Earnings Surprise

Urban Outfitters shares fell nearly 4% after market Monday following the third quarter report. However, the retailer had surprisingly beat analyst estimates. Analysts had predicted revenue of $770 and earnings per share of $0.45, while Urban Outfitters reported revenue of $774 million and EPS of $0.47. However, those weren't the key takeaways from the earnings report.

The company continues to face competition from the likes of Gap and L Brands and could slip in the fourth quarter. However, what were the key points in the third quarter release? 

1. Sales growth and comps 

This is a two-for-one since sales growth and comps growth tend to travel together. 

Urban Outfitters stores accounted for over 44% of overall net sales for the quarter. The namesake-store sales were up 3% year-over-year to about $342 million. Anthropologie sales were up 16% to $310 million and Free People sales were up a whopping 29% to $113 million.   

Urban Outfitters had warned in its second quarter filing that the third quarter was getting off to a slow start with comparable store sales, or comps. The company said comps were starting in the mid single-digits. However, comparable retail sales ended the third up 7% for the total company. 

The weak spot in the third quarter's comps was the namesake chain, which was down 1% compared to the 7% growth in last year's quarter.  Free People maintained its trend of double- digit growth with 30% growth and Anthropologie had 13% growth.

Why the comps drop at namesake stores? The Urban side is much more trend-focused and youth-driven than the others. When there's a general spending pullback on fashion, shoppers tend to prioritize with wardrobe staples such as jeans at the top of the list. And the pullback could've gotten worse for Urban due to an overstocking of trendy items that weren't appealing to customers.

The other stores still maintain strong comps due to having higher priced items and a more financially secure demographic of shoppers.  

2. Improved margins 

Gross margins improved slightly in the third quarter and contributed to an almost 1% improvement in the first nine months of the year. Anthropologie and Free People have better managed their inventory which led to fewer markdowns in those brands. The small size of the margin improvement came about because the namesake stores still had to rely on heavy markdowns due to competition and overstocking. Note that the markdown/overstocking issue again hints toward Urban stores failing to connect with its audience. 

Total inventories increased 3% year over year to $11 million. However, that was due to stocking new and non-comparable stores while comparable-store inventory stayed flat. 

3. Fourth quarter warning 

The earnings report contained a warning that the fourth quarter's results might not prove as jolly. 

"Despite this solid performance we remain cautious about the fourth quarter given the likelihood of a highly promotional environment and this year`s challenging Holiday calendar," said CEO Richard Hayne. 

Urban Outfitters stores don't immediately jump to mind when mentioning holiday shopping. Also, the company has to worry about clothing retailers such as Gap and L Brands who target the same young shoppers. And Gap and L Brands lean more toward clothing staples. 

 Analysts expect Gap to report third quarter revenues of $4 billion and EPS of $0.71.The forecast for L Brands -- owner of Victoria's Secret and Bath & Body Works -- is for $2.2 billion in revenue and EPS of $0.27. 

Foolish final thoughts

Urban Outfitters reported a decent quarter aside from slipping comps at its namesake stores. The company's learning to manage inventories to veer away from margin-injuring promotions, but the fourth quarter's competitive environment could prove rough on the top line. 

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The article 3 Keys to Urban Outfitters' Earnings Surprise originally appeared on Fool.com.

Brandy Betz 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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