A Closer Look At Urban Outfitters Vs. American Eagle Outfitters

Teen clothing retailers have been going through challenging times with American Apparel and Aeropostale filing for bankruptcy and The Limited going out of business. In this challenging environment American Eagle Outfitters (AEO) and Urban Outfitters (NASDAQ:URBN) have been growing steadily. In 2016, AEO’s revenues and comparable sales grew by 4% year to date and the company’s direct to consumer business is witnessing rapid growth. While Urban Outfitters missed consensus estimates in Q3 2017, it registered a 4.5% growth in net sales in this quarter. Both these companies have focused on their digital initiatives to meet the requirements of young consumers who prefer shopping on smartphones and tablets.

We expect revenues of both these companies to reach around $ 4.5 billion by the end of our forecast period, but the EBITDA growth of AEO is likely to be higher.

AEO enjoys higher margins compared to Urban Outfitters due to a better operating leverage and we expect these margins to remain steady over our forecast period.

However, given that it is smaller in size compared to AEO, Urban Outfitters is likely to experience higher growth in number of stores over our forecast period. We expect its other stores to increase from around 133 in 2017 to nearly 185 by the end of our forecast period. AEO already has more than 900 namesake stores and we do not expect any significant growth in this number over the next few years. However, for AEO we expect its direct channel revenues to increase rapidly over our forecast period.

For both these companies, keeping the store expansion in check is critical for long term profitability. Their target audience (young consumers) are more likely to use online channels for their shopping and hence a balance between digital initiatives and physical store expansion is critical. Both companies are likely to maintain this balance and, hence from a larger base of more than 900 stores, AEO is not likely to expand physical stores rapidly. Urban Outfitters has more opportunities for growth in physical stores and it is likely to leverage them.  The company operates stores in three different formats. Its larger namesake stores, slightly smaller Anthropologie stores and the smallest Free People, Terrain and BHLDN stores.

However, the key for profitability for both companies is to generate higher revenues per square foot and managing inventories better. We expect Urban Outfitters to manage its inventories better over our forecast period with a higher inventory ratio.

Also, we expect Urban Outfitters to accumulate higher cash on its balance sheet over our forecast period. This is primarily because Urban Outfitters has not been paying dividends historically and we do not forecast a dividend initiation in our model. The company can use this cash balance for inorganic growth (acquisitions) or is likely to initiate dividends in future.  AEO on the other hand has been paying dividends and we expect this trend to continue over our forecast period – leading to no surges in its cash balance.

We are bullish on both AEO and Urban Outfitters with our price estimates for both companies being more than 30% higher than the market. We believe growth opportunities for AEO are more in the digital channel and the company is likely to limit its store growth. For Urban Outfitters on the other hand, store growth is likely in the future along with expansion of its e commerce initiatives. While AEO has higher margins, both companies are likely to experience a similar revenue growth in the next five years. With a stable business, higher margins and steady dividends AEO appears to be a safe investment. Urban Outfitters however holds a strong growth potential with store and digital expansion in future and, with abundant cash flow, can either fund the possible initiation of dividend or future acquisitions.

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