Owing to tepid retail sales and slumping profit margins, shares of specialty retailer Urban Outfitters (URBN) - Get Report have been struggling, down some 17% in just the past three months. At around $27 per share, URBN stock, which Thursday made a new 52-week low of $26.20, has lost some 23% of its value in 2015, including a 33% decline since April. If you've followed my advice and avoided URBN stock in August, you've saved about 15%. Comparatively, URBN stock does seem attractive today, especially at a P/E of 16, which is five points below the S&P 500 (SPX) . But the business improvements needed to turn me bullish on this stock have yet to occur.
Headquartered in Philadelphia, Urban Outfitters reports third-quarter 2015 results after the closing bell Monday. Based on declining consensus earnings per share estimates, it would seem analysts lack confidence about the company's direction. And falling estimates are a bad sign for a stock that's already trading near its 52-week low.
For the quarter that ended in October, the analysts' average estimate calls for earnings of 43 cents a share on revenue of $872.8 million, compared to the year-ago quarter, when the company earned 35 cents a share on revenue of $814 million. At the start of the quarter, the forecast EPS number was at 45 cents. Now, the currently forecast 23% increase in earnings might still seem impressive. But the metrics to deliver those earnings are on the decline.
In the second quarter, for instance, despite a 7% increase in revenue (which missed Wall Street's estimates), Urban Outfitters' gross profit rate declined 70 basis points to 36.7%. This led to a 60 basis point decline in net income, reaching 7.7%. Combine these metrics with a 30 basis point increase in expenses, the picture they paint is of a company still suffering from inefficiencies in its operation.
And here's the thing: In the second quarter, revenue for its wholesale segment surged 21%. This increase, which grew three percentage points faster than in the first quarter, suggests Urban Outfitters resorted to aggressive discounting to move merchandise. But even then, total inventory still grew by over 7%, implying that those discounting strategies -- combined with higher marketing expenses -- didn't yield the results the company had hoped for, given that second-quarter revenue still missed analysts' projections.
I expect more of the same for the third quarter. Urban Outfitters, which competes with the likes of Forever 21 and H&M -- two chains that have quickly grown in popularity among millennials -- wants to grow market share. To do so, it has had to sacrifice profit margins, which has led to its stock being punished. Until profit margins and revenue begin trending in the right direction, the stock -- despite its consensus hold rating -- should be avoided.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.