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Investors in Urban Outfitters (URBN) were pleased with a solid set of second quarter results which continue to show that the underlying strength of the retail business is intact. The solid results caused relief after several competitors have seen weakness in comparable sale growth lately.

The superior execution and very strong online direct-to-consumer channel warrant the premium valuation for the retailer. Shares continue to offer long-term appeal as the solid growth rate, and very strong balance sheet, form a strong foundation for future growth.

Second Quarter Results

Urban Outfitters generated second quarter revenues of $758.5 million, up 12.1% on the year before. Growth was driven by a 9% increase in comparable sales, which includes the contribution from the direct-to-consumer channel, and surpassed consensus estimates of 8.1%.

Despite the solid growth, revenues came in just below consensus estimates of $768.4 million.

Net earnings rose by 24.6% to $76.4 million, as earnings per share rose to $0.51 per share, thereby beating consensus estimates by three cents.

Looking Into The Results

Growth in revenues was driven by a solid performance of all the major brands. Revenues at Urban Outfitters itself rose by 8.3% to $336.6 million, while Anthropologie reported an 11.8% increase in sales to $315.1 million. The Free People division reported a 31.8% increase in revenues to $97.2 million.

Gross profits rose by 169 basis points on the back of a reduction in merchandise markdowns, especially at the Anthropologie brand. Selling, general and administrative expenses rose by 14 basis points to 23.6% on the back of customer acquisition and retention programs.

Valuation

Urban Outfitters ended the second quarter with $741 million in cash, equivalents and marketable securities. The company operates without the assumption of debt for a solid net cash position.

Revenues for the first six months came in at $1.41 billion, up 13.0% on the year before. Earnings rose by 29.6% to $123.4 million. Full year revenues could come in between $3.1 and $3.2 billion, while earnings could come in around $300 million.

Trading around $43 per share, the market values Urban Outfitters around $6.3 billion, or its operating assets at $5.5 billion. As such, operating assets are valued around 1.75 times annual revenues and 18 times earnings.

Urban Outfitters does not pay a dividend at the moment.

Some Historical Perspective

Over the past decade, Urban Outfitters has created a lot of value for its shareholders. Shares have risen from merely $5 in 2003 to highs of $45 in May of this year. The jump following this earnings report sees shares trading around $43 per share after a modest correction in recent weeks.

Underlying these returns has been an excellent operational performance and share buybacks. Revenues have risen by a cumulative 44% between the calendar year of 2009 and 2012 to $2.79 billion. Net earnings rose by 8% to $237 million. At the same time, Urban retired roughly 13% of its shares outstanding, thereby boosting earnings per share growth.

Investment Thesis

Back in March of this year I took a look at Urban Outfitters' prospects after the company released its fourth quarter results.

I applauded the strong revenue growth, driven by the direct-to-consumer operations, which makes up roughly a quarter of total sales. The solid profit performance over the past quarter has been attributed to more full price-sell troughs and lower markdowns of merchandise.

For the entire year, Urban anticipated to open 35 to 40 new stores of which were 16 new Urban Outfitters stores, 9 new Anthropologie stores and 14 new Free People stores. An anticipated 6 of these stores will be opened in Europe.

As such Urban Outfitters is upbeat about the rest of the year, although it did not issue full-year guidance. Other clothing retailers including Abercrombie & Fitch (NYSE:ANF) and Aeropostale (NYSE:ARO) have seen worsening operational performance in recent times, while Urban's lower price point and merchandise works well in this tougher consumer environment.

Urban Outfitters has a rock-solid balance sheet allowing the firm to fuel expansion, repurchase shares, make acquisitions, or do a combination of these. Backing out the cash position of the firm, and Urban trades at 18 times earnings. While this is high, the current comparable store growth rates more than justify such a valuation, especially given the solid performance at Free People and the strong direct-to-consumer business.

The current performance more than validates the current valuation as the long-term appeal remains, given that the company has a solid balance sheet to further please investors.

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.

Source: Urban Outfitters: Premium Valuation Warranted On Strong Operating Performance, Balance Sheet