Free People and Anthropologie Allowing Urban Outfitters To Thrive Despite a Tough Apparel Market

Senior Equity Analyst

David Swartz

Although performing well in a tough environment, we believe Urban Outfitters lacks a brand intangible asset that would provide an economic moat and pricing power. While we think its three major apparel brands--Anthropologie, Free People, and Urban Outfitters--remain enticing to their primary demographic of women 18-45 years old, we also think competition has taken a toll. Urban Outfitters grew to be one of the larger specialty apparel retailers in the United States on the strength of its distinctive styles. However, it has a history of inconsistent same-store sales growth and profit margins, and its namesake banner is struggling. While this is partly due to shifting fashion trends, we think fragmentation in apparel retail is the primary factor. Urban Outfitters, like many others, has had to resort to markdowns and promotions to compete with wide-moat Amazon and other e-commerce, outlet stores, discount stores, and key vendors’ direct-to-consumer efforts.

Urban Outfitters has strengths, but we view its strategies as insufficient. The firm intends to prioritize e-commerce, international expansion, Free People Movement, and its Nuuly clothing rental and resale service. To its credit, Urban Outfitters was an early adopter of e-commerce, which grew at double-digit rates during the pandemic and now accounts for about 50% of its sales. However, digital shoppers have many alternatives and can even find the company’s brands through third parties. Meanwhile, Urban Outfitters has operated a wholesale business for more than 35 years, but it accounted for just 5% of sales in fiscal 2023. We think this business has been challenged by consistently declining sales in U.S. department stores. Urban Outfitters might have growth opportunities in Europe, where it is opening stores, and in China, where it is has a local team to sell through Tmall. However, the potential for international growth is unproven, as neither Free People nor Anthropologie has any real presence outside North America.

Business Strategy & Outlook

We assign a no-moat rating to Urban Outfitters, as we do not believe any of its three key brands (Urban Outfitters, Anthropologie, Free People) has established a competitive advantage in the form of an intangible brand asset or cost edge. Urban Outfitters’ three major retail chains are highly dependent on sales of apparel, specifically apparel for women 18-45 years old. We believe Urban Outfitters lacks the differentiated product and brand strength to maintain premium pricing in this extremely competitive market. In the United States (87% of fiscal 2023 sales), Urban Outfitters competes with other fashion chains, discount stores, department stores, mass market retailers, e-commerce, outlets, and specialty chains. As evidence of its lack of a competitive edge, Urban Outfitters’ annual operating margins and returns on invested capital have declined over the past decade. The firm consistently achieved annual operating margins above 15% in fiscal years 2005-11 but has not done so since then. We forecast its long-term operating margins at 8%-8.5%. Similarly, Urban Outfitters’ ROICs have trended downwards from fiscal 2014’s 18%. We forecast average annual ROICs of 12% for the company over the next decade, not much higher than our 10.5% estimate for its weighted average cost of capital. We lack confidence that Urban Outfitters can generate economic profit for more than 10 years, as required for a narrow moat rating.

Urban Outfitters’ primary business of apparel retail is highly competitive. While the firm has diversified into home goods, accessories, and other categories, apparel accounted for 63% of its net sales in fiscal 2023. Most of Urban Outfitters’ clothing is sold through its company-owned Anthropologie, Free People, and Urban Outfitters stores. In fiscal 2023, retail operations accounted for more than 90% of its revenue and operating income. Urban Outfitters is a small retailer, with about 700 worldwide company-owned stores, more than 80% of which are in the U.S. While the U.S. apparel market is large, it is also extremely fragmented. According to Euromonitor, U.S. apparel and footwear specialty retailers generated $189 billion in retail sales in 2022, but Urban Outfitters’ market share was only 1%. Given its small market share, we do not think it has the power to negotiate favorable prices from vendors or suppliers.

We do not think the merchandise sold in Urban Outfitters’ eponymous banner is sufficiently differentiated to draw shoppers from the many alternate channels or to command premium pricing. The chain carries both private-label brands and national brands like Wrangler, Lee, Levi’s, Adidas, Patagonia, narrow-moat Hanesbrands’ Champion, and narrow-moat VF’s Vans. Apparel and footwear from these national brands are widely available at department stores, outlet stores, specialty stores, e-commerce sites, and elsewhere. While Urban Outfitters carries some exclusive products from major brands, much of its name-brand merchandise is not exclusive. For example, the chain carries Converse and Adidas shoes that are widely available at similar prices at Foot Locker, no-moat Dick’s Sporting Goods, no-moat Kohl’s, and many other retailers. We think Urban Outfitters has good relationships with its vendors. However, with fewer than 200 stores in the U.S., it is a small retail partner for many brands. Many key suppliers are holding their most popular items for their own stores and e-commerce and a small number of favored retailers. Moreover, many vendors are opening their own stores and building loyalty clubs and drawing customers from traditional retailers. We do not think the chain has the brand strength to keep its young adult consumers from going elsewhere to purchase similar apparel and other merchandise.

Similarly, we do not think Urban Outfitters’ Anthropologie provides a moat. Anthropologie has significant fashion risk and exposure to malls. The chain, which mainly caters to women ages 30-45, carries a mixture of private-label brands, national brands such as Levi’s and UGG, and little-known exclusive brands. While Anthropologie carries everything from bar soap to large sofas, women’s apparel and accessories account for most of its sales. Anthropologie sits in the crowded middle part of this market, as most of its handbags and dresses retail for less than $250. We believe women shop at Anthropologie when it stocks the latest on-trend fashions. Thus, the chain tends to do well when it gets fashion trends right and poorly when it gets them wrong. Moreover, competitors will quickly copy any categories that are unusually strong, and we think Anthropologie has little ability to draw shoppers consistently. Further, roughly 50% of the chain's U.S. stores are in malls. Many malls have suffered declines in customer traffic over the past few years and the COVID-19 crisis has accelerated mall closures. Indeed, although recent results have been impressive, the banner recorded same-store sales below 2.5% in five of the past eight years, and we forecast same-store sales growth of just 2% in the long term. We think Anthropologie, Urban Outfitters’ largest chain by sales, is struggling to compete with other traditional retailers and online sellers. 

We do not think Urban Outfitters’ wholesale business or Free People (which accounts for most of the firm’s wholesale revenue) provides any durable brand power. Urban Outfitters’ wholesale business is small and has suffered declining margins. The firm introduced its wholesale women’s apparel line, Free People, in 1984. Known for its bohemian and active styles, Free People is a niche brand (less than $200 million in wholesale sales expected this year) targeted at women ages 25-35. Free People is carried at some upscale stores but is not a luxury brand, as most items are under $100. For example, Nordstrom Rack, narrow-moat Nordstrom’s discount chain, carries hundreds of Free People products priced under $50. Urban Outfitters’ wholesale sales remain below prepandemic levels and composed just 5% of its revenue in fiscal 2023. Moreover, operating margins for the segment came in below 20% in each of the last five years, down from the mid-20s in fiscal years 2013-15. We think exposure to U.S. department stores is hurting Urban Outfitters’ wholesale business as many of these stores have suffered declining operating margins and traffic. We think Free People, like most other women’s apparel brands, lacks the brand strength for lasting pricing power. 

Urban Outfitters operates stores under the Free People and Free People Movement nameplates, but we do not think they provide a competitive edge. There are now nearly 200 Free People and Movement stores, more than 90% of which are in North America. Free People, like Anthropologie, mainly carries midprice apparel. Most Free People dresses and jackets, for example, retail for less than $200. Similarly, Free People Movement leggings retail for about $30-$40 less than similar leggings sold by narrow-moat Lululemon. Over the past few years, the Free People segment has generally achieved better same-store sales growth than Urban Outfitters’ other chains, but it remains the smallest of the three. We think Free People lacks broad appeal, and we do not expect it will grow to be as large as Urban Outfitters’ other two key brands until after 2030. We do not think Free People is strong or big enough to contribute an economic moat for the company.

We think the inconsistency in Urban Outfitters’ same-store sales can be attributed to increasing competition and declining store traffic. The firm is very fashion-forward and, as such, experiences ups and downs based on style trends. We think, though, that long-term trends have been negative as the large number of alternative shopping channels has drawn traffic away from its stores. We think slow store traffic is reflected in Urban Outfitters’ annual comparable sales growth results, which have exceeded 2% in just three of the past nine years. We forecast Urban Outfitters’ overall long-term same-store sales growth at roughly 3%. We project long-term comparable sales growth of 4% for Free People and 2% for both Anthropologie and the Urban Outfitters segments, in line with our expectations for apparel retail in the U.S. We expect Urban Outfitters will struggle to gain share against its many competitors with similar merchandise.

We believe store counts for all three of Urban Outfitters’ major chains are nearing their saturation points in the U.S. and that international growth will be modest. Free People (including Movement) has the most potential for growth. Its U.S. store count grew to 188 from 30 between fiscal years 2009 and 2023 (including 31 Movement stores), and we anticipate continuing expansion. Meanwhile, the Urban Outfitters chain added nearly 60 stores (net) in the U.S. in fiscal 2009-14. Between fiscal 2014 and fiscal 2023, however, its store base in the region increased by just seven stores (net). Anthropologie, too, grew by nearly 60 stores in the U.S. between fiscal 2009 and fiscal 2014. However, its U.S. store count has been basically static over the past five years. As Urban Outfitters admits that both Anthropologie and Urban Outfitters are close to their store limits in the U.S., the firm is targeting store growth in international markets. Thus far, however, growth for both in these markets has been limited, as they face many established competitors with more stores, greater financial resources, and better understanding of local consumers. International sales accounted for just 13% of Urban Outfitters’ fiscal 2023 revenue. 

Urban Outfitters’ insignificant food and beverage business provides no competitive edge. The firm has made some small investments in restaurant concepts over the years. In 2015, it acquired the Vetri Family restaurant group and suggested it would expand the Pizzeria Vetri concept. Now, though, there are no clear growth plans for the business. While some retailers have successfully used a restaurant business to generate income and increase retail sales, food and beverage accounts for less than 1% of Urban Outfitters’ total revenue. We think food and beverage operations provide little value to the core retail business and serve as a distraction for management.

We do not think Urban Outfitters’ clothing rental and resale service, Nuuly, has changed the company’s competitive position. Although growing rapidly, the business only accounts for a mid-single-digit percentage of Urban Outfitters’ total sales and has yet to reach profitability. We do not forecast for Nuuly to generate a material level of operating profit in at least the next 10 years.

We do not believe Urban Outfitters has a moat based on a brand intangible asset, a cost advantage, or any other source. A small number of large apparel retailers have created a cost advantage by negotiating lower rates from suppliers and getting new products into their stores faster than others. Urban Outfitters, though, is not a fast fashion producer. The firm, like most competitors, sources most of its merchandise from many third-party manufacturers in Asia and other regions. We do not believe it has the power to negotiate lower prices from these producers as there are many competitors who buy clothing in larger volumes than Urban Outfitters. While the firm is investing to increase the efficiency of its supply chain, its competitors are doing the same. We believe they all have access to similar technology and systems. Further, we do not think it has a moat based on efficient scale, as the market size and potential for returns have not impeded entry by competitors. Finally, there are no network effects or switching costs in apparel retail.

None

Economic Moat

Urban Outfitters

Urban Outfitters, Inc. engages in the operation of a general consumer product retail and wholesale business selling to customers through various channels including retail locations, websites, catalogs, and mobile applications. It operates through the following segments: Retail, Wholesale and Subscription. The Retail segment contains the Anthropologie, BHLDN, Free People, Terrain, and Urban Outfitters brands and its Food and Beverage division. The Wholesale segment designs, develops, and markets apparel, intimates, active wear, and home goods under the Free People, Anthropologie, and Urban Outfitters brands. The Subscription segment consists of the Nuuly brand, which is a monthly women’s apparel subscription rental service. The company was founded by Richard A. Hayne and Scott A. Belair in 1970 and is headquartered at Philadelphia, PA.

Earnings data Q3 2023

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