Urban Outfitters (NASDAQ:URBN) operates its namesake stores in the U.S., Canada and Europe. We estimate that these stores contribute roughly 30% to the retailer’s value and form the second most important business segment after its direct-to-consumer channel.
Over the past few years, the revenue share of Urban Outfitters stores has come down due to decreasing productivity, or profitability per store. The revenue per square foot declined initially due to the recession of 2008-2009 and later because of an imbalance in women’s merchandise mix. Going forward, we expect this figure to improve with improving economy, international expansion, aggressive marketing and increased focus on women’s apparel business.
Snapshot Of Urban Outfitters Stores
Urban Outfitters stores offer women’s and men’s fashion apparel, footwear and accessories as well as an eclectic mix of apartment wares and gifts. Apartment wares include rugs, pillows, shower curtains and books, candles and novelties.
The brand mainly targets young adults between 18-28 years of age, whom it identifies as culturally sophisticated, self-expressive and concerned with acceptance in their peer group.  Rather than advertising its products, Urban Outfitters tries to sell a lifestyle to its customers by creating a unique in-store shopping experience. The brand tries to add a greater appeal to its merchandise by offering edgy and eclectic products such as Hands Off tee, wrapping paper with offensive language, Dictators with Attitude tees, patchwork dress, neon maxi dress and others.   This, along with attractive prices, has enabled the brand to build a loyal customer base.
Why Has This Segment Struggled?
Historically, Urban Outfitters has expanded its namesakes stores at a good pace. The brand’s global store count increased from 114 in 2007 to 215 in 2012. Despite this, its share of the retailer’s overall revenues dropped from 42% to 37% during the same period due to declining productivity. In 2008, these stores generated $610 in revenue per square foot, and the figure came down to $588 in 2009.  The slowdown in the U.S. economy led to a decrease in transactions, lower units per transaction and lower average unit sales prices. After a minor rebound in 2010 to $591, the figure slumped by 8% in 2011 due to an imbalance in women’s apparel product mix that led to surplus inventory.  
To clear the slow moving inventory, the company had to usher large scale promotions for its merchandise, which significantly impacted Urban Outfitters’ average unit retail (AUR) prices. This, along with the product returns at Urban Outfitters’ stores, weighed on the brand’s growth in 2012 as well. 
How Can It Recover?
Urban Outfitters is undertaking some important steps to address this issue, which should help it going forward.
Revamped Marketing To Better Connect With Customers: Urban Outfitters is reinforcing its data analytics team to make customer communication more actualized. Over the long run, the retailer plans to reduce its catalog circulation and promote web-based and digital communication.  Also, it is increasingly investing in image makers, marketers and stylists to conceive a fascinating brand experience for its customers.  Once such example is FP Me by Free People brand, which allows customers to create online profiles, connect with fashion lovers and share various styles and collections’ photos.  We believe that this will enhance company-customer interactions, which in turn should positively impact its sales.
Greater Focus On Women’s Apparel: Urban Outfitters is trying to have a more balanced product portfolio in order to reach a broader spectrum of customers. It is identifying the underperforming product categories and is specifically working on them. These efforts have been somewhat successful as the 2012 spring collection of knits, wovens and printed tops received good customer responses. If the retailer is able to sustain a firm control over the product mix, it can translate into lower markdowns and ultimately better revenue per square foot.
Targeted Expansion To Improve Store Economics: Rather than expanding aggressively, Urban Outfitters is identifying underpenetrated U.S. and international markets for its expansion where it can generate better revenue per square foot.  In the current fiscal year, the company plans to open eight retail stores in Europe and 29 in the U.S. We believe that Urban Outfitters has ample expansion opportunities in the U.S as some of its competitors such as Aeropostale (NYSE:ARO), American Eagle Outfitters (NYSE:AEO) and Abercrombie & Fitch (NYSE:ANF) operate more than 900 stores in the country. 
We Can Expect Retail Store Expansion In China Soon: Owing to its partnership with World Co. Ltd (a distributor that operates more than 2,700 stores in Asia), we expect Urban Outfitters to soon come out with plans for retail store expansion in China.  It is the second largest apparel market in the world and has been quite lucrative for western retailers. Gap‘s (NYSE:GPS) initial stores in China are generating about 40% more revenue per square feet than its U.S. stores.  Although this figure is likely to decline as Gap expands its footprint in different demographics of the region, the market potential is clearly visible. We believe that Urban Outfitters needs to establish itself here before the market becomes more crowded.
Our price estimate for Urban Outfitters stands at $41, which is slightly ahead of the market price.
Disclosure: No positions.