Prepared by Stephanie, Analyst at team BAD BEAT Investing

Urban Outfitters (URBN) is a retailer that faced a lot of pressure from COVID-19. Even before the pandemic, this was a pretty good stock to trade on both the long and the short side. We recommended taking some profit at the $30 level. The COVID-19 selloff was just about to start when we made that call, but surely we did not see the stock getting smashed down to $12, which we felt was overdone. In May when shares were $15, we felt the stock was a buy and believed that URBN was a second-half survivor. Well, here we are in the last quarter of 2020 and URBN is back. The retailer will report Q3 results in a few weeks and we want to go over the key metrics you should be looking for during that report. Using Q2 as our guide, let us discuss what we are seeing.

Q2 results solid, but will the momentum carry to Q3?

The short answer to this question is ‘yes’ we do believe so. Make no mistake, shutdowns related to COVID-19 decimated much of the specialty retail sector. It has simply been struggling. Even before COVID-19, the signs pointed to slight growth in 2020, which would have been less than stellar, but now the year 2020 is quite clearly going to show contraction for most of retail. Overall, we thought Q2 was good for URBN and think the momentum carries into Q3. There has been a number of earnings revisions higher in the last few weeks. Based on the trajectory of the company over the last few quarters, we could see bets on both sides long and short being justified, though we are mildly bullish on the sector as a whole and the company into 2021. Some of this comes from the strong news of a COVID-19 vaccine looking promising.

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Sales in Q2 were absolutely crushed due to the pandemic, but were better than expected. In fact, revenue fell a whopping 16.5% to $803 million. Trying to pinpoint a true sales estimate was tough and analysts were all over the map on this one, but sales obliterated the consensus by $131.6 million. It was an across the board decline, and the company had to be super promotional to try and push online sales, which did grow. Still it was a solid report. We are looking for declines in Q3, but only in the low double-digits to high single-digits.

That said, comps were ugly. Comparable retail segment net sales decreased 13%, driven by growth in the digital channel, partially offset by negative retail store sales. This was, of course, driven by negative retail store sales due to stores being closed for part of the quarter and lower store productivity once opened, partially offset by strong double-digit growth in the digital channel. By brand, comparable Retail segment net sales increased 11% at Free People and decreased 8% at Urban Outfitters and 25% at the Anthropologie Group. Total Retail segment net sales decreased 14%. Wholesale segment net sales decreased 51%. Ouch. But what is worse, to get those online sales, the company had to be promotional, and that hit margins.

Not only were sales down, but the gross profit rate decreased to 29.6% from 32.8% in the prior year’s comparable period. Gross profit dollars decreased 24.6% to $238.0 million from $315.0 million. The decrease in gross profit rate was due to an increase in delivery and logistics expenses due to penetration of the digital channel, followed by store occupancy expense rate deleverage. The deleverage in store occupancy expense was due to store closures during the quarter as well as lower store sales productivity once stores reopened. Stands to reason. We actually liked that merchandise markdowns were lower in the quarter while initial merchandise mark-up rate was flat versus the prior year’s comparable period. Both the Urban Outfitters and Free People brands delivered record low markdown rates in the quarter. That was a massively hidden positive and we think this strength will spill over into Q3. All told, net income was positive for the quarter. It swung positive from a loss in Q1. Net income was $34 million or $0.35 per share.

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Considerations moving forward

Even before COVID-19, online shopping was growing more popular every year and putting more and more pressure on brick and mortar. However, management here delivered in Q2 and we think that we see strength in Q3 as well. We believe that Urban has had a strong digital presence and the physical locations are mostly reopened now. The present sales report tells us that retail, certainly, is not dead, even for specialty brands. One thing we will look for is the balance sheet. URBN ended the quarter with over $670 million in cash and marketable securities, while repaying $100 million of borrowings from earlier this year. That is strong. We fully believe the company has the cash to last through 2021, even if sales remain pressured terribly, which we do not expect. We correctly thought there would be improvement in all of 2020, and especially in the second half. We are looking forward to a strong Q3 report in a few weeks, and a good holiday quarter.

Final thoughts

Management is taking the proper steps to boost liquidity, protect cash, and get stores reopened. Investments in digital are paying off, and margins are rebounding from earlier in the year. Specialty retail has been absolutely hammered, but we think Urban is a strong name. On the next pullback, consider URBN for a medium-term investment.

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Disclosure: I am/we are long URBN. 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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