Urban Outfitters, Inc. (URBN) is a Pennsylvania based retailer that targets 18-28 year olds by emphasizing cultural sophistication and self-expressiveness. URBN has proven time and again an ability to grow earnings despite the competition of e-commerce retail companies. URBN’s strong earnings growth and report of an increase in holiday sales makes me believe that the stock is currently undervalued and will approach a price of $40-$44 within the next 6 months.
STRONG FINANCIAL STANDING
Urban Outfitters, Inc. is currently trading at a P/E ratio of 16.54 which is well below the industry average of 34.92. This low valuation is based off of consensus’ opinion that Urban Outfitters does not have earnings growth potential moving forward. I disagree with this and based off of a proven ability to generate profit I believe this valuation is around 34% too low. Urban Outfitters is in a very strong financial position. The balance sheet shows a strong current ratio of 2.70 and no outstanding debt. This gives Urban Outfitters the ability to invest in their growth. Thus far in FY 2019 they have already spent $90 million on property and equipment. This investment is up from just $63 million in the same first 9 months of FY 2018. Increasing investment in growth proves to me that Urban Outfitters is committed to continuing their earnings growth. Another factor that leads to my confidence that Urban Outfitters will continue committing to improving their ability to generate income is that the company is 36% insider owned. This high level of insider ownership shows a clear incentive for rewarding shareholder’s moving forward.
Sales have grown at a 5yr CAGR of 5.3% and Urban Outfitters released on January 10th that sales for the first 11 months of FY 2019 have increased by 10% over the same period in FY 2018. This higher than normal growth in sales will be a welcomed sign when URBN releases FY 2019 earnings in early March.
In the past Urban Outfitters has succeeded when its P/E ratio has gotten down to its current levels. In October 2017, the P/E ratio touched these levels and went on a 10-month surge in which it went from $22.50 up to a high of $49. I believe we are in for a similar surge in price of URBN during 2019.
I came up with a price target for this stock based off of a few different valuation techniques. In order to get a very raw price target for URBN we can use Eddy Elfenbein’s “World’s Simplest Stock Valuation” calculated as:
(Growth Rate/2 + 8) · EPS = Fair Value
Urban Outfitters’ next 5-year growth rate is 15.81% and its average estimate for next year’s EPS is $2.91. When we plug this into our stock valuation multiple we get:
(15.81/2 + 8) · 2.91 = $46.28
This valuation passed my hurdle of being at least 30% above the current price of $32.65. This valuation yields a price that is 42% higher than the current market price.
I next used the EPS for each quarter over the last 10 years to estimate what EPS for Q4 FY 2019 may look like. I then added this estimated EPS to the previous 3 quarters earnings and multiplied this by the current P/E ratio. This valuation strategy included a few different layers of conservatism which leaves room for upside in the investment. This conservatism lies in the fact that I am multiplying the TTM EPS by a P/E ratio that I believe is too low for a company that has a lot of growth ahead due to its strong ability to connect with its consumer base. I also deployed conservatism in my valuation by essentially ignoring the fact that there has been unusual sales growth thus far in FY 2019 and especially in Q4 (which is the quarter I am estimating earnings for). By ignoring the information we have that sales have increased significantly in FY 2019, I am allowing for upside on the already impressive earnings potential of my price target.
An important aspect of all my valuations was in how I handled the unusually low EPS of Q4 FY 2018. This quarter yielded an EPS of $.01 due to a one-time income tax expense. Instead of using this value in order to assist in my valuation of the Q4 FY 2019 EPS, I used the Adjusted Diluted EPS of $.69 that was reported in last year’s annual report. This EPS ignores the one-time income tax expense in order to assign a proper earnings value that is more accurate in forecasting the profit of the company.
In the first strategy I used to value URBN, I extrapolated the 10 year CAGR of Q4 and assumed that that same rate of growth would continue into FY2019. I calculated a Q4 10yr CAGR of 5.49%. By assuming continued growth into FY 2019 I calculated a Q4 EPS of $.73. This leads to a TTM EPS of $2.65 and at the current P/E ratio this translates to a valuation of $43.79 per share. I then took this strategy a step further. In order to account for the higher than normal earnings growth rate over the last five years I calculated the Q4 EPS by using a 5yr CAGR. This yielded a slightly higher Q4 CAGR of 5.96%. When extending this growth rate to 2019 the TTM EPS is $2.65 and the valuation is $43.85 which is roughly the same as the previous valuation. These valuations imply an investors profit of approximately 37% before taxes and fees.
In the second strategy, I took the average of all Q4 EPS for the last 10 years. I then assigned this average to the Q4 EPS. This strategy netted a lower TTM EPS of $2.45 and a valuation of $40.47 per share. This strategy is very conservative as it ignores the fact that EPS has been growing at a steady rate over the last ten years
The two conservative price strategies I used estimate a price window of approximately $40-$44. Due to the nature of the current P/E ratio being too low for a company that has strong market position and the financial strength to continue steady earnings growth moving forward I believe these price targets are on the low end. Urban Outfitters has a loyal consumer base and they understand what their consumers want. Urban Outfitters continues to generate high earnings and yet this is being overlooked because brick and mortar companies aren’t as exciting as the flashy e-commerce companies. I do not see any earnings slowdown in sight and soon I believe the market price of URBN will mirror this continued success.