By Brian Sozzi
Purposely, I refrained from putting my thoughts on the disappointing quarter from retailer Urban Outfitters (URBN) on the website immediately. I wanted to see just how many times I would get the question "should I buy the dip?" The question flow has increased, and my answer is to not by the dip. There is something fundamental occurring at Urban Outfitters, a shift in fashion that is not sticking yet. That lack of traction elevates the risk to future earnings on a stock that continues to be priced at a sizable premium to the sector. Premium valuation on a retailer battling merchandising issues, coupled with inflationary pressures in the supply chain, is an elixir worth avoiding.
It has been clear to me that Urban Outfitters is having difficulty incorporating the evolution in women's fashion at the namesake and Anthropologie divisions. My understanding on how long it takes before sales and margins first stabilize, and then grow strongly, amidst a fashion change is about six months. Unfortunately, new rules are being written as Urban Outfitters has minimal solid reads on what the typical female shopper to its stores wants on a consistent basis these days. The female shopper to Urban Outfitters and Anthropologie is delving into the accessories and home furnishings, which drove 4Q11 divisional comps, but scurrying away from the apparel section seeing it as off trend (apparel was missing in action as a driver in the quarter). I have talked to numerous fashion minds and none can specifically identify the trend Urban Outfitters is referencing to in terms of its fashion shift. Big tops over skinnier bottoms is a trend that has been around, and theoretically should play right into the hands of the eclectic assortments found at Urban Outfitters and Anthropologie.
In my view, the issue at hand boils down to fit (unflattering), styling (just missing some wow factor), and the overall value equation to the female consumer. Furthermore, no mention was made about the men's business at Urban Outfitters, an area of the store that I feel is underperforming from holes in the assortment and that strong sense of quality that is vital to selling apparel in the current environment.
Investors are therefore left with an outlook on Urban Outfitters that is much more uncertain than the norm, and will at least be dominated by downside risk to comp and gross margin estimates as a result of fundamental merchandising issues and difficult year earlier comparisons. To paraphrase CEO Glen Senk, the product is hitting the third ring of the dartboard instead of the target. Suffice it to say we expect multiple contraction as margin trajectory is down perhaps for three consecutive quarters, factoring in too much inventory entering 1Q12, fashion risk, and stepped up investment spending to support international and direct to consumer initiatives.
- Prolonged fundamental shift in women's fashion that comes while product inflation is rampant. Not a good combination, as increased markdowns are compared to a higher cost to buy merchandise.
- Increased investment spending against weaker comp and gross margin trends. Leverage point of the business now at a 4% comp.
- Europe not performing up to the level one would think for a new brand on the scene.