Urban Outfitters Stocks Hidden Value

 | Jan 29, 2014 | 2:00 PM EST
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Market confidence that the economy was coming back has had a mixed effect on shares of fashion retailers. To be sure, the beneficiaries have been the fashion-focused department stores such as Nordstrom (JWN), Macy's M, and Michael Kors (KORS), or those that are less exposed to a financially sensitive consumer.

On the opposite extreme, you have mass-merchant retailers, including JCPenney (JCP) and Sears (SHLD), that are struggling amid titans such as Wal-Mart (WMT) and Target (TGT).

Tucked in the middle are fashion labels that are experiencing a cyclical adjustment. One-time darlings such as Aeropostale (AERO) and Abercrombie and Fitch (ANF) are trading at lows trying to reinvent themselves. And some investors have started to look closer at these names as they appear to be trading at very low multiples to future free cash flow.

One name that deserves a close look is Urban Outfitters (URBN), a $5.2 billion operator of retail fashion brands. It's the brands that URBN owns and operates that really make this company an intriguing retailing opportunity. Urban Outfitter operates five distinct brands: Urban Outfitters, Anthropologie, Free People, Terrian, and BHLDN.

The company operates 229 Urban Outfitters stores that offer eclectic fashion inspired by a contemporary love for art, music, and fashion. Focusing on 18 year olds and above, these stores sell men's and women's apparel as well as unique items for the modern home or apartment. Anthropologie is collection of 188 retail stores worldwide that offer a unique array of fashions from the world over that are designed for the fashion conscious women.

You won't find brands fashions such as Kors, Ralph Lauren (RL), or Tory Burch, but rather, chic designs from boutique labels. I believe Anthropologie is a hidden gem inside URBN. I have the best analyst in the world: my wife. She is very fashion wise and she loves this store because you can find anything from a one-of-a-kind shirt for $80 to a dress than will cost $400. Anthropologie also offers unique bedding and kitchen accessories.

Free People is another high-quality boutique label with over 75 stores, but also sells its products to more than 1,500 specialty boutiques. You will find Free People at Nordstrom and other high-quality fashion boutiques. BHLDN is a unique collection of wedding fashions while Terrian offers a unique approach to selling home and garden products.

Shares in URBN currently trade for $36. Despite reporting record holiday sales, the stock price has fallen from $44 in the past 52 weeks. The company has no debt and over $400 million in cash on the balance sheet. Shares do trade at 20x trailing earnings. This is perhaps on the high side of the retailing range, but URBN earnings should continue to grow over the next several years. Its brands offer a unique collection of fashion, a trend that is booming -- especially with today's generation, which is clearly inspired by being unique so as to stand out amid the world of smartphones, social media, Pinterest and everything in between.

URBN is expected to earn $1.84 per share for its fiscal year ending Jan. 31, 2014 and $2.15 per share in fiscal 2015. This is a very solid rate of growth for a retailer in this environment. Investors could see close to $2.40-$2.50 in 2016 as the company adds new stores. At current multiples, that makes URBN a $50 stock in less than two years.

Another way I like to look at it is that the value of the separate brands alone (especially Anthropologie, as a stand-alone business) probably make URBN worth close to $8 billion to $9 billion. The sum of the parts here are clearly worth more than the whole and you get an earnings growth play as well with a company that is earning $400 million in operating cash flow. Free cash flow is closer to $200 million as the company invests in growth.

Anyway you dissect this business, URBN may be one of the most attractive retailing opportunities today -- especially if the continued slide in the market offers a lower entry point.

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