The stock of a lifestyle specialty retailer, Urban Outfitters (NasdaqGS: URBN), is poised for a prosperous future ahead based on the strong business fundamentals, robust financial position, very attractive valuations, and a good double-digit expected long-term earnings growth rate. The stock has returned almost 27% in the last year and still it has a long way to go. Based on the URBN's much cheaper valuations as compared to its industry peers, it has above 36% upside potential to achieve its fair value of $37 in the next one-year investment period.
Source: Yahoo Finance
Note for the Readers:
To keep the essence of my detailed analysis alive, I have separated the Urban Outfitters' entire study into two parts. Part-1 of the analysis (the article you are reading) covers the investment thesis only in terms of valuation point of view. Part-2 of the analysis will cover the investment thesis based on the detailed analysis of the company's business fundamentals, financial position, growth prospects, potential risks to the business, etc. Both pieces (part-1 and part-2) are the essential study for investors who are interested in considering Urban Outfitters for long-term investment prospects. However, I want to add here a paragraph that is related to part-2 of the analysis.
URBN is fundamentally a strong business. Its profitability margins and the return measures are much higher than the industry peers. The fundamentals of its business provide a kind of economic moat to the company. URBN has a debt-free balance sheet with the vigorous cash balance, which translates to a very healthy financial position. Additionally, the company is expected to grow its earnings at a decent double-digit growth rate over the long period of time. Hence, the fundamentals of its business strongly support the investment thesis.
URBN's very attractive valuations make the stock a strong candidate for a well-diversified investment portfolio. I used the two relative valuation approaches to value the stock: 1) Enterprise level valuation (EV/EBITDA model), and 2) Equity level valuation (P/E model and P/CF model). Both valuation approaches indicated that the stock is very much undervalued and offers a strong margin of safety to prospective risk investors.
First, look at the EV/EBITDA model. URBN's EV/EBITDA multiple is 7.32x as compared to the apparel industry's EV/EBITDA multiple of 9.93x, which indicates that the URBN is undervalued and offers a good bargain investment opportunity. It has an enterprise value (NYSE:EV) of $3.67 billion. Using the company's EBITDA of $501.60 million, the model derived EV resulted to $4.98 billion. Because the company has no debt on its balance sheet, adding the cash balance and then dividing the resulting equity value with total shares outstanding resulted in the intrinsic value of $45.09/share. This represents an upside potential of almost 66% from the current price level.
Source: Author Calculations/ Seeking Alpha
Now turn your intention to equity-level relative valuation multiples to see what they predict about URBN. Please have a look at the following current valuation table which presents a very interesting picture of URBN in comparison with industry averages and the broader market. All of the four relative valuation multiples of the company are much cheaper than both the industry averages and the overall market. This is a clear indication that the URBN's stock is undervalued and is a good candidate to consider for the investment. Additionally, these measures are well below the company's own five-year average values. The trend of these relative valuation multiples is also shown in the valuation's graph below to the "current valuation" table, which is downward sloping, a positive omen for the stock investors.
In this area of equity multiple valuation, I used price-to-earnings (P/E) multiple and price-to-cash flow (P/CF) multiple to value URBN's stock. Both multiples predicted that the stock is undervalued. First, look at the P/E multiple's results. I used forward P/E multiples for the purpose. The forward-looking P/E multiple of URBN is 13.20x as compared to apparel industry's forward multiple of 18.30x. Yes, the stock looks undervalued based on this criterion. Using the fiscal 2017 EPS (expected) of$1.93, the model derived the fair value (intrinsic value) of the stock of $35.32/share, which is an above 30% upside potential from the now price.
Next, the P/CF model also derived a similar conclusion. The P/CF multiple of URBN is 7.70x (as reported in the current valuation table) as compared to the industry's multiple of 10.70x, a very clean undervaluation omen. Using the company's reported cash flow per share of$3.56, the model suggested a fair value of URBN is $38.10/share ($3.56*10.70), which offers upside potential of about 41% from the current price level. I used operating cash flow per share in the model.
Source: Author Calculations
The following two graphs show the URBN's historical P/E and P/CF multiples as compared to broader market index (S&P 500) historical multiples for the same. As it can be seen in the trends, both multiples of the company are now lower than the market multiples when compared to historical basis. This is another addition to the valuations that support my investment thesis.
If we look at the forward P/E multiple over the next few years, it seems to be even more attractive to support the investment thesis. Look at the below Price/Earnings Ratio graph that shows forward P/E multiples for the next few years. The good thing is that the price-earnings trade-off looking favorable as the long-term expected earnings growth rate for URBN is 13.20%, which makes the multiple striking.
Lastly, combining the technical perspective with the fundamental analysis always make the investment case stronger. Relative strength index (RSI) is a widely used technical indicator in investment analysis. Look at the graph below, which reports RSI of 31.51 for URBN. Wonderful, this is a solid buy point that strongly supports my investment thesis.
Based on the above valuation models and being pessimistic in valuation approach, I set the fair value of the URBN's stock to $37/share, which offers a very strong upside potential of almost 37% in the next one-year investment horizon. This target price is nicely supported by the analysts' consensus target price of$35.39/share. Additionally, the consensus forecasts for the URBN, as shown by the below graphs, also favors the strong buy call for the stock. According to the Financial Times, the highest target price forecast is $45/share and the median target price forecast is $33/share.
Source: Financial Times
Disclosure: I/we 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.