Shares of Urban Outfitters (NASDAQ:URBN) saw some greater than normal volatility last week as analysts disagreed on the shares prospects. At the start of the week, shares got downgraded only to receive an upgrade a day later.
Given the solid growth and improving external environment, I remain cautiously optimistic for the outlook of Urban's shares.
The Pessimistic Side
On Tuesday, analyst Morry Brown from Wedbush downgraded Urban Outfitters from outperform to a neutral rating, slashing the price target by $9 to $37 per share.
The key driver behind the downgrade are the risks associated with the Anthropologie brand. Brown has noted a big increase in sales promotions which would suggest a potential slowdown in sales. Yet Brown acknowledges that sales trends at Anthropologie remain among the best of the sector. That being said, a slowdown could still have a real impact.
While Brown sees no impact on sales for the core Urban brand, given that in-line promotions and clearance results are in line, the company has ¨less margin for error¨ amidst the slowdown in Anthropologie sales trends. These comments sound a bit confusing to me, given that the namesake Urban Outfitters brand performed poorly in the first quarter, while Anhropologie's sales were very strong.
And The Optimistic Side
Just a day following the downgrade, analysts at Macquarie upgraded the stock from neutral to outperform while hiking the price target by six dollars to $43 per share.
Unlike Wedbush, analysts at Macquarie see continued growth and sales momentum at Urban's brands. With the back-to-school season starting, analyst Dunn believes Urban will continue to perform well. The smaller store base compared to many of its competitors and the more differentiated products and concepts are a pro as well in this environment.
At the same time the full year earnings guidance was hiked by four cents to $2.00 per share, while hiking the five year growth rate to 17%. As discussed later, this growth rate in sales seems a bit aggressive in my eyes.
Back in April, Urban Outfitters released its first quarter results. The company ended the quarter with $518 million in cash, equivalents and marketable securities. The company does not have any debt outstanding, resulting in a comfortable net cash position.
Total first quarter sales were up by 6% to $686 million. As a matter of fact earnings fell on smaller gross margins and higher selling costs, which combined triggered a more than 20% decline with earnings coming in at $37.5 million.
For the quarter, gross margins were down by 210 basis points due to the negative sales leverage at its namesake Urban Outfitters brand, driven by poor performing product lines. Sales, general & administrative expenses were up by nearly 50 basis points as a result of higher marketing expenses to keep traffic up.
The first quarter issues were clearly isolated to the Urban Outfitters brand which posted a 12% decline in comparable sales and an overall 5.2% fall in sales towards $277.7 million.
Sales at Anthropologie were up 10.3% to $295.8 million, thereby surpassing Urban Outfitter's brand, driven by a healthy 8% increase in comparable sales. The star performer was the Free People division at which comparable sales rose by 25%, while new store openings pushed total sales growth to 30% with sales reaching $108.7 million.
On the back of the first quarter earnings release shares lost about 10% on the back of the news. Shares are now down about 7% so far in 2014 which looks bad given the solid market performance, yet many other clothing retailers have fared much worse.
A week after the earnings release and the subsequent fall in the share price, the board of Urban approved a 10 million share repurchases program, sufficient to repurchase about 7% of the outstanding float. Even when completed at current levels, Urban will still hold a solid net cash position.
Yet the long term growth story remains solid despite the current hiccups. Between 2005 and 2014, Urban has increased sales from little over $800 million to nearly $3.1 billion, growing sales at a compounded annual growth rate of nearly 16%. Over the past five years this rate came in at 10%.
More impressive, the company achieved this while repurchasing 10-15% of its shares over the past decade. It should be noted that net margins have been under relative pressure in recent years, not keeping trend with sales growth. Given the compounded annual growth rate of 16% over the past decade, and 10% over the past five years, the 17% anticipated growth by analysts at Macquarie for the coming five years seems quite ambitious.
At $34.50, Urban Outfitters commands a market valuation of $4.75 billion or little over $4.2 billion after subtracting its solid net cash position. This values operations at around 1.35 times sales and 15-16 times earnings.
While retail clothing is not the best industry to operate in at the moment, the company is still growing at solid rates overall, has a rocks solid balance sheet and has demonstrated strong historical growth. While there are certainly problems at its core brands, the other two chains are stepping up at the moment, creating appeal in my eyes as discussed when I looked upon Urban's prospects back in May.
Clearly the short term disagreement among analysts relates to current sales momentum with Wedbush warning for weakness at Anthropologie after a very decent first quarter after. Macquarie sees things moving along just fine, just as the improved weather is providing some much-needed tailwinds for the retail sector. Its long term growth assumptions are on the high side in my opinion.
Time will tell with Urban scheduled to reports its second quarter earnings in August of this year. I remain cautiously optimistic.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.