Weak sales at Urban Ouftitters are a concern. Debt and weak free cash flow are even more of a concern.
Urban Outfitters (URBN -9.57%) stock tumbled 10% through 10:10 a.m. ET Thursday morning, despite the company beating analyst forecasts for second-quarter sales and earnings last night.
Heading into the results, analysts forecast the teen retailer would earn $1 per share on sales of $1.34 billion. In fact, profits were a superb $1.24 per share, and sales edged out the consensus estimate at $1.35 billion. Sales grew 6% year over year, and profits were up twice that — 13%.
Urban Outfitters’ Q2 earnings
That’s the good news. Now here’s the bad: While sales grew nicely in three of Urban Outfitters’ four biggest brands (Anthropologie, Free People, and Nuuly), same-store sales at Urban Outfitters stores themselves declined 9.3%, which as CNBC points out, was worse than expected, and total Urban Outfitters sales slid 8.6%.
This seems to be what worried investors today: weakness in the company’s best-known brand. And yet, while Urban Outfitters is obviously the store brand best identified with the company, it’s not the biggest part of the business at all. Both Anthropologie and Free People generate stronger sales for the company — and apparently, based on this quarter’s results, stronger profit margins as well.
So did investors overreact to this single data point?
Is Urban Outfitters stock a buy?
Perhaps. After all, at $3.5 billion in market capitalization, Urban Outfitters stock appears to sell for a cheap 11.3 times trailing earnings. This would make the stock seem an obvious buy except for two things. The first is debt. Urban Outfitters carries about $540 million more debt than cash on its balance sheet, lifting its enterprise value to $4 billion. The second is free cash flow. At $242 million, this lags reported net income. As a result, it turns out Urban Outfitters sells for an enterprise value-to-free-cash-flow ratio of not 11.3, but 16.5.
While still not obviously expensive, that’s probably a bit too much to pay for a stock with a long-term expected earnings growth rate of only 8%. This valuation is the main reason I feel Urban Outfitters is not a buy.
Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
