Urban Outfitters: Strong Online Performance Supports Premium Valuation

| About: Urban Outfitters, (URBN)

Shares of Urban Outfitters (NASDAQ:URBN) ended Tuesday's trading session up .75% after witnessing losses of up to 3% just after the opening. The retail apparel company, known for its brands like Urban Outfitters, Anthropologie, Free People and Terrain reported its fourth quarter results for its fiscal year of 2013, after the market close on Monday.

Fourth Quarter Results

Urban Outfitters generated fourth quarter revenues of $857 million, up 17% compared to the year before. Comparable retail sales rose 11%, driven by online direct-to-consumer channels, while comparable stores sales came in flat.

Sales at the Urban Outfitter division rose 16.5%, coming in at $415.5 million. Sales at Anthropologie rose 11.9% to $334.8 million, while the Free People franchise reported an almost 40% increase in revenues, coming in at $97.7 million.

For the quarter, total revenues at its retail stores rose 8.5% to $577.6 million. Impressive was the 44.1% increase in direct-to-consumer revenues, driven by the online success of the group.

Gross profits for the business rose an impressive 650 basis points due to a reduction in merchandise markdowns across all of its brands. Gross margins came in at 36.6%. Selling, general & administrative expenses fell 7 basis points to 21.2% as positive sales leverage was partially offset by higher equity compensation expenses and additional investments in the online operations.

The company reported a 110% increase in net income as a result of the strong revenue growth and margin expansion. Net earnings came in at $82.5 million, with earnings per share coming in at $0.56 per share. Earnings per share came in line with analysts expectations, but missed whisper earnings by two cents.

CEO Richard Hayne commented on the performance during the holiday quarter,

"I congratulate each of our brand and shared service teams for delivering an excellent fourth quarter. We entered the year with a plan to invest in initiatives to drive top line growth and improve margins. We succeeded on both fronts especially in the fourth quarter. We will pursue a similar strategy in the current fiscal year as we believe we have only begun to unlock the opportunities ahead of us."


Urban Outfitters ended the fiscal year of 2013 with $623 million in cash, equivalents and marketable securities. The company operates without any debt outstanding, for a comfortable net cash position.

The company generated annual revenues of $2.79 billion for the full year of 2012. Full year earnings came in at $237.3 million, or $1.62 per diluted share.

The market currently values the company around $6.0 billion. Excluding the net cash position, operating assets are valued around $5.4 billion. This values the firm's operating assets around 1.9 times annual revenues and 22-23 times annual earnings.

Despite the strong financial positions, Urban Outfitters does not pay a dividend at the moment.

Some Historical Perspective

Since 2004, shares of Urban Outfitters have traded in a wide trading range between $15-$40 per share. At the moment shares are exchanging hands a little over $40 per share, around their all time highs. Over the past year alone, shares have returned some 40%, setting all time highs around $44 in January of this year.

Between 2008 and 2012, Urban Outfitters has grown its annual revenues by a cumulative 50% to $2.79 billion. Net income rose some 20% to $237 million. Earnings per share rose even faster as the company retired roughly 15% of its shares outstanding over the time period.

Comparative Valuations

Investors award Urban Outfitters growth strategy, in particular the strong online sales growth, by attaching a premium valuation to the company's shares. The company trades at 1.9 times annual revenues and 22-23 times 2013's earnings.

This valuation compares to a market value of $17.4 billion for The Gap (NYSE:GPS). This values the company which is known from brands like The Gap, Old Navy and Banana Republic at approximately 1.2 times its annual revenues and roughly 20 times annual earnings.

American Eagle Outfitters (NYSE:AEO) is valued at around $3.5 billion, net of $600 million in net cash. This values the firm at 1.0 times annual revenues and 15 times annual earnings.

Abercrombie & Fitch (NYSE:ANF) is valued around $3.3 billion, net of $600 million in net cash. This values the firm at 0.8 times annual revenues and 26 times annual earnings.

Accelerating Operating leverage

Online revenues rose an incredible 44.1% in the quarter compared to the year before. In the fourth quarter, direct-to-consumer revenues made up 28.1% of total sales. This was up 440 basis points compared to the full year results, and up 530 basis points compared to the fourth quarter of 2012.

Note that the online, direct-to-consumer operations of Urban Outfitters have become crucial for the firm and its valuation. The unit already generates over a quarter of sales, and similar growth rates like those in the final quarter of 2012 could increase firm-wide revenues by over 12%, assuming all other sales channels report flat growth.

More importantly is the positive feedback loop in terms of profitability as centralized distribution allows for greater gross margins and lower selling, general & administrative expenses. On top of this becomes the lower capital intensity of the online operations. Online operations furthermore tend to have less of a cannibalizing effect on existing brick-and-mortar sales, compared to a strategy of expanding its existing store base.

Investment Thesis

Investors are in general pleased with Urban Outfitters' performance as shares are trading near their all time highs. In general the latest report indicates little news to investors. The company already published its annual revenues back in February of this year, and the earnings publication came in line with expectations.

Overall, investors are still very upbeat about Urban Outfitter's operations, and its growth profile. Consequently, the company trades at premium earnings and revenue multiples compared to many of its competitors. Crucial is the solid growth rate of the business, propelled by the online operations.

Investors are very pleased with these revenue trends as online sales tend to be more profitable compared to brick-and-mortar operations. Online sales carry much lower selling, general and administrative expenses and allow for better and more centralized inventory management, thereby boosting gross margins. The focus of the business is therefore diverting from its brick-and-mortar business towards the online sales channels.

At the same time, I would stay on the sidelines despite the favorable developments, especially in terms of the online direct-to-consumer channel. While I like the prospects of the business, the high valuations leave little room for short-term triggers to the upside. At the same time, the positive underlying trends will continue to propel the shares forward in the medium to long term, making this stock extremely dangerous to short as the company can grow rather fast into its valuation.

I remain on the sidelines for now.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.