Shrinking Margins Could Stymie Urban Outfitters
Summary
- URBN reports quarterly earnings after hours.
- Margins have been falling due to discounting needed to move its burgeoning inventory balance.
- Shrinking margins and higher logistics expenses pursuant to the digital channel could cause operating income to fall hard.
- Sell URBN.
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Source: Barron's
Urban Outfitters (NASDAQ:URBN) reports quarterly earnings Tuesday. Analysts expect revenue of $1.17 billion and EPS of $0.63. The revenue estimate implies 4% growth Y/Y. Investors should focus on the following key items.
Stagnant Revenue Growth
Revenue growth has been stagnant for retailers, while margins have been under pressure. If revenue grows 4% this quarter then it could imply a solid holiday season for Urban Outfitters. Last quarter the company generated $987 million, up 1% Y/Y. The retail operations grew 2% Y/Y, while the wholesale segment fell 7%. Nuuly, the company's subscription rental business for apparel, generated $2 million in revenue. The brand was launched at the beginning of the third quarter, and could generate a new revenue stream from customers interested in vintage items.
On a brand basis, revenue from Urban Outfitters rose 5% Y/Y, Anthropologie Group Fell 3% and Free People rose 2%. Comparable retail net sales for Free People and Anthropologie Group rose 9% and 4%, respectively. Comparable retail net sales for the Urban Outfitters brand was flat. Women's apparel at Urban Outfitters and Anthropologie was a disappointment. Correcting any fashion misses could take a few quarters, if at all. Women's fashion could be a key area to watch this quarter.
Margins Are Deteriorating
Falling margins could offset solid revenue growth this quarter. Last quarter the company reported gross profit of $321 million down 5% Y/Y. Gross margin was 32.5%, about 200 basis points below that of the year-earlier period. The company had been hampered by higher markdowns in women's apparel and deleverage in store occupancy. Last quarter margin erosion was driven by an elevated level of inventory, higher logistics expenses due to higher penetration by the digital channel, and higher discounts within the wholesale segment.
The retail industry has been defined by a heightened promotional environment. Margins at Kohl's (KSS) and Abercrombie & Fitch (ANF) have also suffered due to discounts needed to drive traffic to stores. As more revenue is derived via the digital channel, logistics expenses at Urban Outfitters could continue to rise. This could crimp margins further.
SG&A expense was $246 million, up 2% Y/Y. As a percentage of revenue, SG&A expense increased about 10 basis points versus the year-earlier period. With margins shrinking, Urban Outfitters must cut into SG&A costs if it wants to grow operating income. That could be difficult. The company must invest in its digital channel and fulfillment capabilities to keep pace with larger retailers like Target (TGT) and Walmart (WMT). As a result, operating income of $75 million fell by double digits. The operating income margin was 7.7%, down about 230 basis points versus the year-earlier period. The decline in operating income could offset revenue growth again this quarter.
Ballooning Inventory
The company's inventory is ballooning as margins are eroding. In the October quarter, inventory swelled to $532 million. Based on cost of sales through the last 12 months ("LTM") October 2019, inventory days outstanding were 75. This was much higher than the 52 days outstanding for year-end 2018, and the 53 days outstanding for year-end 2017.
The company likely grew inventory even more to prepare for the holiday season. The question remains, "Can Urban Outfitters sell down its inventory balance?" Rising inventory and whether the company needs to discount product to move stale inventory could drive the narrative this quarter.
Conclusion
URBN is down over 20% Y/Y. Sinking margins may not abate anytime soon. Sell URBN into earnings.
This article was written by
Analyst’s 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.
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Comments (1)
I was watching it and you did an excellent job there since 2016FreightCar America, Inc. (RAIL)
What is the real problem of this company?
They have manageable debt and US $ 5.00 per share in cash