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Morningstar | No-Moat Urban Outfitters Should Benefit From Strengthened Merchandising and Demand Longer Term

Urban Outfitters has a portfolio of distinct, well-defined brands that transcend product type and functionality. The stores are carefully curated to offer a niche customer a one-stop shopping experience from apparel to home goods. However, we believe Urban Outfitters is at an inflection point, transitioning into a more mature company.Management has acknowledged that the store base of Urban Outfitters and Anthropologie has topped out in the U.S., a notion we support, given declines in brick-and-mortar traffic. Although we think the brands still have a significant runway in international markets, we think consolidated store unit growth will decline from the midsingle digits seen on average annually over the last five years to the low single digits on average over the next five years.Given moderating expansion, we also expect cost demands to ease. Therefore, we expect growth in selling, general, and administrative expenses to fall from high single digits on average over the last decade to midsingle digits going forward and for capital expenditures as a percentage of revenue to fall from 7% in 2015 to below 4% over the long run. We think cost-control efforts will help moderate the impact of higher shipping expenses associated with shifts toward direct-to-consumer sales.However, we still believe that any apparel company's long-term growth prospects will be determined by its ability to match products with consumer demand. We think management is doing everything right by increasing exposure to nonapparel merchandise and speeding the supply chain to increase newness and reduce discounting. That said, Urban's high-fashion products could make performance volatile as merchandisers attempt to predict trends. We think it will take time for the growth components to scale, with wholesale and international sales approximating less than 10% and 13% of revenue, respectively. Over time, we expect operating margins to find a floor around 8% over our forecast period (versus the 9% three-year historical average) as shifts to lower-margin direct-to-consumer sales are offset by less deleveraging and possible rent renegotiations.