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One Leader Exists Amongst a Sea of Retail Laggards

|Includes:AEO, ANF, ARO, BEBE, DDS, GYMB, JCP, KSS, LB, M, PLCE, PSUN, ROST, TGT, TJX, Urban Outfitters, Inc. (URBN), WMT, WTSL, ZUMZ

Not all retailers are created equal.  Some companies benefit as a result of economic conditions, while some fair well no matter the signs of the time.  The divergence in execution by management, and the specific business model in question, separates the winners from the losers in retail when things get trying in the economy.  Just look at the sad stories of Circuit City, Filenes Basement, Linens N’ Things, and Caldor (hey, I am a native Long Islander who was dragged to this decrepit store as a child).  Conversely, there are success stories, such as Best Buy (NYSE:BBY), Wal-Mart (NYSE:WMT), and Kohl’s (NYSE:KSS). I continue to expect a thinning of the ranks in the specialty retail sector over the next several years.  My base case assumes a reemergence of consumer spending, below the levels seen in 2005-2007, but an allocation of dollars to select retailers providing one or all of the following (1) value in the product, (2) differentiation in the types of merchandise offered, (3) unparalleled customer service, and (4) top-flight websites that sell goods unavailable in the stores, which creates sort of a treasure hunt mentality among the customer base.  Within my equity coverage universe, Urban Outfitters Inc. (NASDAQ:URBN) rises to the surface of retailers likely to operate quite well in what I have coined the “new realities” in the retail sector.

Key considerations for Urban Outfitters:

* Sector: Specialty Apparel
* PE multiple: 21.6x estimated January 2011 ended EPS
* Five-year normalized PE multiple: 30.76x
* Zero debt
* Has beaten consensus earnings estimates by an average of 6.4% from October 2007 quarter

Company description:

The company is a lifestyle specialty retail concern that operates under the Urban Outfitters, Anthropologie, Free People, and Terrain brands.  It also operates a wholesale segment under the Free People and Leifsdottir brands.  The company has over 38 years of experience creating and managing retail stores that offer highly differentiated collections of fashion apparel, accessories, and home goods in inviting and dynamic store settings. 

* Urban Outfitters: 36.0% of annual sales; 142 stores in the U.S. and Europe
* Anthropologie: 35.0% of annual sales: 121 stores in the U.S.
* Terrain: 1.0% of annual sales; 1 store in the U.S.
* Free People (wholesale): 5.8% of annual sales
* Remainder of sales generated from online operations of each brand

Investment Thesis

Contrary to popular belief, there will be winners amongst specialty apparel retailers as the U.S. savings rate continues its march to 10.0% (around 5.0% presently).   The company has all the things we seek in a long-term investment, including (1) founder still deeply involved in operations, (2) no debt, (3) highly differentiated model (offering consumers merchandise not being supplied by competitors), and (4) ample room to push the business model domestically and abroad.  At first blush, the stock, valued at 21.6x projected EPS for calendar 2010, would appear modestly pricey in an environment of pressured consumer demand for non-essential goods.  However, Urban Outfitters has historically been an aggressive grower of its earnings base, and by extension, returns on assets and equity.  As a result, the stock deserves a premium PE multiple relative to others in specialty apparel, and at present, actually trades at a nice discount to the normalized five-year average.  Even acknowledging the company may not return to peak 20.0% operating margins as seen in 2006 and 2007 as debt becomes less of an impetus to spend on the part of the consumer, it’s our view that applying a reasonable multiple of 26.0x estimated profits for calendar 2011 of $1.75 per share (assumes a 19.0% operating margin) yields a stock north of $40.00.   The company’s square footage growth and efficiency in operations, such as speed to market and quick markdown strategy, are how we are modeling for the attainment of that 19.00% operating margin.

Written by Brian Sozzi, a Research Analyst for Wall Street Strategies ( specializing in the apparel/hardline goods sectors of the retail industry.  For more information about Mr. Sozzi, refer to the company's website,