Retailer Urban Outfitters (click ticker for report: ) posted strong second quarter results Monday afternoon. For the second quarter of its 2013 fiscal year, revenue grew 11% year-over-year to $676 million, which was better than expected–even with same-store sales falling 1% during the quarter. Earnings grew 20% to $0.42 per share, coming in significantly higher than consensus estimates.
Though gross margins fell 30 basis points year-over-year to 37.6%, this isn’t very surprising given the growth of the company’s Free People concept, which is highly leveraged to smaller wholesaling margins. Free People, still in its infancy, has replaced Anthropology as the fastest-growing segment of the company. Free People sells to over 1,400 retail outlets, including department stores like Nordstrom (click ticker for report: ) and through its own stores. Same-store sales at Free People grew 12%, driving total growth of 26%, to $74 million during the period. While it’s still a small portion of the revenue mix, we expect the brand to continue to perform well in the near term, though it remains as leveraged to fashion trends as any other brand.
Same-store sales at Urban Outfitters stores were reasonably strong, growing 6% year-over-year and driving total segment growth of 14%, to $310 million. Since the storefront is almost entirely tied to the fashion and tastes of fickle teens and young adults, the firm has struggled to recapture its strong margins from the mid to late 2000’s. Regardless, comparable inventory per store has fallen 5% year-over-year, and the flagship brand appears to be delivering consumers the “right” product. On the other hand, Anthropology remains weak, with same-store sales flat and revenue up just 3% year-over-year. Anthropology carries merchandise with slower turns than Urban Outfitters and Free People. However, we think the brand became a bit too aggressive with pricing after its rapid growth phase, and management has stated prices will come down to 2010 levels.
Management doesn’t give guidance, but the firm plans to open 51 stores in the back half of its 2013 fiscal year. CEO and co-founder Richard Hayne seems optimistic about the firm’s runway in Northern Europe and continues to invest in spite of a bleak macroeconomic outlook. Brick-and-mortar expansion will be important to the overall growth of the retailer, but the company has also expanded its web offerings by 50% and saw web traffic increase 31% during the second quarter.
Regardless, we aren’t fans of Urban Outfitters at current levels. Shares now trade in excess of our fair value estimate and its Valuentum Buying Index score of 3 indicates now is not a great time to enter the stock. Additionally, we’ve followed the roads of other retailers heavily exposed to teens and young adults—Aeropostale (click ticker for report: ), Abercrombie & Fitch (click ticker for report: ) and American Eagle (click ticker for report: )—it tends to be a bumpy one. Unlike the Zara’s and h&m’s of the world, which can quickly bring items that are in fashion to market, these retailers have to bet on future tastes, which is no easy task.