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Stock Market Sell-Off: Is Urban Outfitters a Buy?

Motley Fool - Thu Apr 20, 8:53AM CDT

It is worth taking a deep dive when a stock is performing very differently from the market and its peers. That's exactly the case today with retailer Urban Outfitters(NASDAQ: URBN). What's going on? Is there a reason to think it can continue to excel relative to peers and the market? Here's a quick look at what's been going on.

Rising while others fall

Urban Outfitters stock is up 5.5% over the past year. That compares to a decline of 5% for the S&P 500 index over the same span, which is pretty impressive outperformance. However, the teen-oriented fashion retailer looks even better when you compare it to peers like American Eagle Outfitters(NYSE: AEO) and Abercrombie & Fitch(NYSE: ANF). Those two retailers have fallen 21% and 27%, respectively, over the past 12 months.

Teens shopping at mall.

Image source: Getty Images.

The story here really boils down to Urban Outfitters' business holding up fairly well as peers struggled. For example, in fiscal 2023, Urban Outfitters' sales rose 5.4% compared to flat sales at both American Eagle and Abercrombie & Fitch over the same time frame (technically fiscal 2022 for this pair). That's notable given the mercurial nature of the customers these companies target, suggesting that Urban Outfitters resonated more with teens in 2022 then did the brands owned by its peers.

Despite that top-line result, all these retailers faced material headwinds in 2022 because of inflation. Urban Outfitters' gross profit margin declined from 32.8% in fiscal 2022 to 29.8% in fiscal 2023, a full 300-basis-point drop. But American Eagle's gross profit margin dropped from 39.7% in 2021 to 35% last year, a 470-basis-point decline. And Abercrombie & Fitch's gross profit margin slipped 540 basis points, going from 62.3% in 2021 to 56.9% in 2022. So while all these retailers were dealing with similar issues, Urban Outfitters appears to have handled the headwinds slightly better. It's not shocking that the stock handily outdistanced its peers.

Things can change quickly

Does that make Urban Outfitters a buy today? That's a harder call to make, given that the stock's outperformance over the past year is clearly pricing in a lot of good news. And, as noted, teens can be fickle. In this case, switching brand affinities only requires walking to a different store, which is not much of a hurdle. Basically, more conservative investors should probably think twice before looking at teen fashion at all.

Chart showing Urban Outfitters' price higher than the SPDR S&P 500 ETF Trust and 2 of its competitors since late 2022.

ANF data by YCharts

But if you are looking at Urban Outfitters, there are a few issues worth highlighting. For the company's Anthropologie nameplate, management is projecting a solid year in fiscal 2024 with an explication of positive comparable store sales.

However, the company's Urban Outfitters brand had a difficult year-end in fiscal 2023, with comparable sales down 10% in the fourth quarter. While management is projecting better results thanks to an improvement in supply chain speed times, this division's management team is being overhauled. That materially increases the chance of a business misstep. Meanwhile, the Free People brand is expecting to see sales decline as its department store customers continue to struggle.

This means that performance at two of the three largest divisions at Urban Outfitters is projected to be either uncertain or weak. Together, the Urban Outfitters and Free People brands make up 55% of the retailer's sales. That's not to suggest that the business will come crashing down if these divisions don't do well. Urban Outfitters will muddle through and deal with any issues that arise.

However, given the stock's outperformance relative to peers, if these two divisions struggle, Wall Street might turn more negative on the shares. It will be well worth investors' effort to listen to the upcoming earnings conference calls to keep track of how the company's largest nameplates are doing. Bad news could be treated extra harshly by investors.

Switching places

If you look back over time, the stocks of teen retailers often move in the same general direction. But there always appears to be one company that's the standout performer relative to the others. That standout seems to be Urban Outfitters of late.

History suggests this relative strength won't last forever. And given management's comment about fiscal 2024, it seems like there's uncertainty at the company's namesake brand and downright weakness expected at Free People. Investors should probably be more worried about a reversion to the mean here than excited for a continuation of the current outperformance.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends American Eagle Outfitters. The Motley Fool has a disclosure policy.

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