Best in Class: Urban Outfitters Drives Sales Without Sales

There are times in life when it pays to be a contrarian -- and the same goes for the life of a company. Such is the case with Urban Outfitters ( URBN), a firm out to prove that, even in trying times, bottom-barrel prices are not the sole means to a sale.

Despite today's heated pricing wars, the contemporary apparel chain is sticking to a simple notion: give shoppers a unique product they love, and even the cash-strapped will pay full price.

As the retail world prepares to enter its second-quarter earnings-report frenzy, it's an approach that has netted the company TheStreet's distinction as Best in Class for contemporary clothing.

Don't believe us? Believe the numbers:
Urban Outfitters Comps Outshine Competition

And then there are these numbers: Shares in Urban Outfitters are up 36% in the year-to-date period, closing Monday at $21.81 -- up almost three dollars in the last week alone.

Indeed, while most of its competition like Abercrombie & Fitch ( ANF) and American Eagle Outfitters ( AEO) have resorted to drastically lowering prices in an effort to lure any warm, sentient body into their stores, Urban Outfitters is going the other way. By managing inventory broad and shallow rather than narrow and deep (meaning it has more styles with fewer items in each style), Urban Outfitters is selling more product at full price.

"We have trained consumers to buy product when they see it rather than wait for it to go on sale," CFO John Kyees said in a recent exclusive interview with TheStreet. "They know the next time they come into the store it might not be there. When you sell commodities you need to compete on price, but we are selling fashion."

This strategy has allowed Urban Outfitters to report record sales and earnings in 2008, even as the rest of the retail sector crumbled.

"We never looked at the recession with any doubt of our survival," Kyees said. "We actually view it as an opportunity."

Granted, the Urban Outfitters approach hasn't only been one of mere strategy. The company's brand of warfare has employed its share of shrewd tactics, too.

Urban, for starters, has taken advantage of the recession by securing better rents in malls. "There are not a lot of people growing their store base, so it's easier to negotiate terms with malls," Kyees said. "We can also get better rates on store construction."

The contemporary retailer is on track to open about 42 new locations by the end of the year.

And while Urban faces tougher comparisons in 2009 (first quarter earnings declined 28% to $30.8 million, or 18 cents a share) and is not forecasting a stellar year, it still has several levers to drive future earnings growth, including: shorter lead times, lower product costs, lower lease and construction costs, plus growing wholesale, direct and international business, Roth Capital Partner's analyst Elizabeth Pierce wrote in a recent research note.

And management says that these various levers will all be employed to meet their long-term goals: revenue growth of 20%, operating margins back near 20%, and EPS growth that exceeds revenue growth.

Ending the year with $521 million in cash and no debt, Urban also has substantial liquidity to invest.

Then there is the fact that with only about 290 stores across four concepts -- Urban Outfitters, Anthropologie, Free People and Terrain -- the company boasts significant room to expand. Kyees predicts that the current concepts have the potential to grow to about 800 locations.

"Urban Outfitters is one of about five real growth stories left in apparel retail, with 15% square-foot growth across three of its concepts," Needham & Co. analyst Christine Chen says.

Kyees expects Urban Outfitters, Anthropologie and Free People will reach saturation in about five years. "Our goal is to never let any one concept become too large," he said. "As our CEO Glen Senk says, 'big is the enemy of cool.' You are no longer a specialty store when you have 700 to 1,000 stores."

And while five years gives management more than enough time to come up with additional growth concepts, Urban has already mapped the future for last year's launch of garden center Terrain and wholesaler Leifsdottir.

Terrain currently only has one store in Philadelphia, but Kyees estimates the garden industry is about an $85 billion business. "While Terrain won't be an overnight growth story, it does have potential," Chen said. "Unfortunately, it hasn't been well-received by investors since they don't understand it. But investors didn't understand Anthropologie when it was first rolled out and the concept has been immensely successful for the company."

Leifsdottir, however, has been a winner since its launch last July, and has been selling out in department stores like Nordstrom ( JWN). It has done so well, in fact, that Kyees said Leifsdottir has the potential to become a retail concept.

"These two concepts may or may not work," Kyees said. "But all of our growth is very deliberate. Unlike some companies, which wait until they have reached maximum growth before developing another concept, Urban Outfitters' management wants to give new concepts time to develop. Some of the concepts that closed recently could have succeeded if they had enough time to live and grow naturally."

Case in point: Last month, Abercrombie & Fitch announced it will shutter its Ruehl concept, while American Eagle's Martin + Osa has been speculated to be next on the chopping block according to analysts.

But Urban, according to Kyees, will rely on more than just Terrain and Leifsdottir down the road. He says he also expects the company to roll out another two to four concepts, with the added possibility of a small acquisition.

He also cites opening doors overseas, particularly in Asia, as another means of growth. And the direct-to-consumer segment, which currently comprises 15% of company sales is slated to soon drive 20% of total business.

Too ambitious? Time will tell. But not to this company, which is actually thinking bigger than single stores. Last year the company launched its first "lifestyle center," called Space15Twenty, in Los Angeles. A self-described "retail experiment," it boasts an outdoor musical performance space, a curated art gallery, film exhibits, one-off installations by new designers, and a rotating collection of complimentary vendors.

Sounds like the work of a true contrarian.

Which of the following retailers do you think will report the best earnings?

Urban Outfitters
Abercrombie & Fitch
American Eagle Outfitters

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