The Key to Urban Outfitters Isn't Urban Outfitters

Some investors don't understand Urban Outfitters . This is part of the reason why the stock has underperformed Abercrombie & Fitch's stock year to date. Abercrombie & Fitch is a potential turnaround story, but Urban Outfitters doesn't require a turnaround. It would require a turnaround if you were only basing your investment on its namesake brand, but its namesake brand -- Urban Outfitters -- is just one piece to a much larger puzzle. Furthermore, Foolish investors focus on underlying company strength, not short-term stock fluctuations. 

Understanding Urban Outfitters
Urban Outfitters is made up of several brands. This includes its namesake brand, Anthropologie Group (Anthropologie/Bhldn), Free People, and Terrain. As far as Terrain goes, these are only two garden centers in the United States and will not play a role in the following analysis.

In the first quarter, Urban Outfitters stores in North America generated 32.4% of net sales, and Urban Outfitters stores in Europe generated 8.1% of net sales. Therefore, Urban Outfitters is important, but contrary to popular belief, it's not as important as Anthropologie Group.

In the first quarter, Anthropologie Group stores in North America generated 41.8% of net sales, and Anthropologie Group stores in Europe generated 1.3% of net sales. What really stands out here is that Anthropologie Group stores in North America generated 40.3% sales in the year-ago quarter. This indicates a moderate growth of importance. Meanwhile, Urban Outfitters stores in North America generated 38% of net sales in the year-ago quarter; this indicates a moderate reduction of weighted importance in the namesake brand. Keep this in mind as we dive a little deeper.

Free People (retail, not wholesale) generated 9.1% of net sales in the first quarter. That's not a big percentage, but it's a significant jump from 7.3% in the year-ago quarter.

Prior to looking at some key numbers, consider that Urban Outfitters plans on opening 35-40 new stores in fiscal-year 2015. This is expected to include 12 Urban Outfitters, 15 Anthropologie, and 12 Free People stores. While most retailers targeting teens and young adults are closing stores to cut costs and increase profitability, Urban Outfitters is opening more stores -- a sign that upper management is confident in the company's future prospects.

Telling numbers
The company's namesake brand -- Urban Outfitters -- suffered a 12% comps sales decline in the first quarter year over year. That's a big hit, but remember that the company's namesake brand's importance is reducing.

Comps sales at Anthropologie Group improved 8% year over year. If a retailer is diversified and it has a brand that's performing well, then there is potential, especially if that brand's comps sales improved 8% year over year.

Then there's Free People, which delivered a whopping 25% comps sales gain for the quarter. Free People is on fire, and there is no sign of a slowdown.

Logically, if Urban Outfitters is ever in a bind, it can close underperforming Urban Outfitters locations and use the freed up capital for increased investments in its stronger brands. In addition to the mostly positive numbers above, wholesale comps sales jumped 27% year over year, and wholesale generates 6.7% of net sales.

Urban Outfitters vs. Abercrombie & Fitch
Overall, Urban Outfitters reported flat comps sales for the first quarter, but this unimpressive number was primarily due to the company's namesake brand. Remove that brand, which isn't the most important anyway, and you have a winning company. Comparatively, overall comps sales for Abercrombie & Fitch declined 4% in its first quarter. For further proof that Urban Outfitters is more in line with industry trends (for now) than Abercrombie & Fitch, consider the top-line comparison chart below:

ANF Revenue (TTM) Chart

Abercrombie & Fitch revenue (trailing-12 months) data by YCharts

However, if you're a Foolish-type investor, then you want to know about free cash flow. While past results don't guarantee future results, Urban Outfitters has consistently generated more cash flow over the past decade:

URBN Free Cash Flow (Annual) Chart

URBN Free Cash Flow (Annual) data by YCharts

This free cash flow generation leads to the potential for capital investments in innovation, new store expansion, marketing, and capital returns to shareholders.  

The Foolish bottom line
Abercrombie & Fitch will likely survive. It might even thrive again at one point down the road. It's an innovative company with a comprehensive game plan to reignite growth, and failing peers will help it steal share. On the other hand, it's still a much riskier investment than Urban Outfitters, which is underappreciated by investors and doesn't require a turnaround.

Anthropologie Group is seeing demand, and Free People is one of the best-performing retail brands in existence right now. The catch here is that Free People is still relatively small.  Small brands that are growing and delivering in big ways often present opportunities. This is on top of the solid performance of Anthropologie Group. Overall, Urban Outfitters is highly diversified, and it owns two on-trend brands. These are positive signs.

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Dan Moskowitz 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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