By  on January 14, 2008

After suffering a year of slowing growth due to merchandise misses, Urban Outfitters Inc. spent most of 2007 working to reposition itself and has now emerged as the top stock pick from several analysts.

Efforts to improve its business have begun to show, particularly at the Anthropologie division.

"We are the one story that is contrary to what is currently happening in retail," said John Kyees, chief financial officer of the specialty retailer, during a Needham & Co. growth conference last week.

While most of the apparel industry had a humdrum holiday, earlier this month Urban Outfitters reported a 9 percent jump in same-store sales for the November and December period. This compares with a 5 percent decline in the same period last year. By division, comps rose 5 percent at Urban Outfitters, and soared 16 and 17 percent at Anthropologie and Free People, respectively.

"We believe that Urban Outfitters is one of the best growth stories in the specialty retail space and should be a core holding for retail investors," said Christine Chen, retail analyst at Needham & Co., in a research note. "In 2008, Urban Outfitters faces easier same-store sales and margin comparisons, and we continue to believe merchandise adjustments are accelerating the turnaround at Urban Outfitters."

Amid a slowdown in consumer spending, Urban Outfitters is one of the few apparel retailers that has been able to consistently post positive comps and operating margins throughout the year. This follows three quarters of declining sales and profits.

Carrying this momentum is the Anthropologie division.

Glen Senk, who was appointed chief executive in May, has made sweeping changes in processes and merchandising strategy, bringing back what made the division unique, said Roxanne Meyer, retail analyst at CIBC World Markets.

The success of the chain comes from its ability to entice shoppers of a broad age range. With a sweet spot in the 25- to 40-year-old demographic, the business caters to a wealthier customer, who is a little more immune to economic downturns.

"The product is dead-on, and during the holiday season there were long lines at the register and fitting room. Visiting the Anthropologie stores you would think we were in the best market environment ever," Meyer said.In 2007 Anthropologie made up 47 percent of sales for the company, and analysts say it can continue doing its part as the Urban Outfitters division recovers. But the key is getting both divisions to work at the same time, said Brad Stephens, retail analyst at Morgan Keegan & Co., who added a small dose of skepticism.

"Everyone is saying Urban is in the midst of a turnaround, but the question is, are they back on track or is this a function of easy comp comparisons and more aggressive promotions?" he said. "Compared to December's putrid comps, relatively, Urban looks great. But I am not sure we are back where we need to be." The company took a hard hit in 2006 when its merchandise became too fashion-forward, and the retailer tried to bank on the big-over-small silhouette.

"Urban Outfitters is a merchant-centric organization. When they were on, they were spot-on for two to three years. But when they missed, they missed big," Stephans said. "They were managing the upside but not the downside, so when they missed it got ugly because there weren't a lot of controls in place."

"The biggest positive of the company, that each division was able to operate as a separate entity, is also what hurt them. By decentralizing the organization, the best practices from each weren't shared," Meyer said.

However, analysts say it does seem like the retailer is beginning to gain control over its inventory. And with a shortage of designers to create its private label merchandise, the Urban Outfitters division is going through a massive hiring process.

With only about 242 Urban Outfitter, Anthropologie, and Free People stores as of December, the company expects it can grow to about 750 stores domestically and internationally.

"Few retailers are growing stores at about 20 percent," Meyer said. "They are nowhere near maximum capacity or saturation."

Urban Outfitters is also working to open its fourth concept, called Terrain — an up-scale landscape and garden retailer.

"The concept is not expected to be our guiding light. I have eight years to figure it out, and if it doesn't work I will think of something else," Kyees said. "But we have never started a concept and closed it. We are purposely slow and deliberate."And Kyees announced a fifth concept is also on the horizon. The concept, which will be unveiled at the end of the year, will be more in line with the apparel businesses.

The Philadelphia-based company has sales of $1.4 billion, with a 23 percent compound annual growth since going public in 1993. In the third quarter, earnings rose 31 percent to $45.4 million, or 27 cents a diluted share, while sales increased 23 percent to $379.3 million.

And the stock has held up better than others in this tough macroeconomic environment. Since its lowest day of trading on Aug. 9 2006, shares have soared over 90 percent. For the year-to-date period, shares are up about 2.7 percent, closing at $26.15 on Jan. 10.

But the company's struggle taught it how to better manage inventory, make more scientific and planned real estate decisions, and control store costs, Kyees said.

"Though the last year was painful for management and investors, it was essential as a learning lesson for the business," he said.

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