Contents – Urban Outfitters – Spring ?· Contents – Urban Outfitters – Spring 2007 ... Urban…

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    Contents Urban Outfitters Spring 2007 Executive Summary 2

    Accounting Analysis 3 Ratio Analysis Forecast Financials 4 Intrinsic Evaluations 4

    Overview of URBN and the Industry 5 Five Forces Model 7 Rivalry Among Existing Firms 8 Threat of New Entrants 12 Threat of Substitute Products 15 Bargaining Power of Buyers 16 Bargaining Power of Suppliers 16 Value Chain Analysis 17 Competitive Advantage Analysis 18

    Accounting Analysis 19 Key Accounting Policies 20 Accounting Flexibility 22 Evaluating Accounting Strategy 23 Quality of Disclosure 26 Revenue Manipulation Diagnostics 29 Expense Manipulation Diagnostics 32 Potential Red Flags 34 Fixing Accounting Distortions 35

    Financial Analysis 37 Liquidity Analysis 37 Profitability Analysis 45 Capital Structure Analysis 53 Ratio Analysis with Lease Capitalization 55 IGR and SGR Analysis 58 Forecasting 64 Cost of Capital 66

    Intrinsic Valuation Analysis 69 Methods of Comparables 70 Intrinsic Valuation Models 73

    Free Cash Flows 73 Long Run ROE Perpetuity 75 Residual Income 76 Abnormal Earnings Growth 77

    Altman Z-Score 79 Analyst Recommendation 79

    Appendix A - Valuation 81 Appendix B Forecasted Ratio Analysis 85 Works Cited 86

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    Executive Summary URBN Investment Recommendation: Overvalued, Sell (As of 04/01/2007) URBN NYSE - $26.21 52 week range $13.65 27.75 Revenue (2006) $1,224,717 Market Capitalization $4.33 Billion Shares Outstanding 165,080,000 3-month Avg. Daily Trading Volume 3,347,150 Percent Institutional Ownership 73.00% Book Value Per Share (mrq) $4.093 ROE 18.80 % ROA 12.29% Est. 5 year EPS Growth Rate 4.09% Cost of Capital Est. R2 Beta Ke Ke Estimated 20.6% 5-year .2601 3.92 20.6% 1-Year .2630 3.93 20.6% 10-Year .2063 3.92 20.6% 3-month .2624 3.93 20.6% Published 2.51 Revised Ke: 14.8% Kd URBN: 5.60% WACC URBN: 19.77% revised: 15% Altman Z-Score URBN: 15.33

    EPS Forecast FYE 01/31 2006(A) 2007(E) 2008(E) 2009(E) EPS 0.79 0.61 0.68 0.75 Ratio Comparison URBN ANF JCG Trailing P/E $38.04 $18.18 $27.92 Forward P/E $22.21 $13.88 $26.18 P/B $6.42 $5.30 $448.94 Valuation Estimates Actual Price (as of 04/01/2007) $26.20 Ratio Based Valuations P/E Trailing $17.02 P/E Forward $13.55 Enterprise Value $18.00 P/B $24.49 Price/ FCF N/A Price/ EBITDA $15.25 Intrinsic Valuations Actual Free Cash Flows $21.40 Residual Income $3.19 LR ROE $3.40 Abnormal Earnings Growth $17.85

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    General Note:

    For the remainder of this valuation, each company will be hereon

    referred to by its ticker symbol. The following ticker symbols will represent

    the following companies: URBN - Urban Outfitters, ANF - Abercrombie & Fitch,

    and JCG - J Crew.

    Recommendation-Overvalued Firm

    Company, Industry Overview and Analysis

    Urban Outfitters Inc. is a pioneering lifestyle merchandising company that

    operates specialty retail stores under the Urban Outfitters, Anthropologie and Free

    People brands. It was founded in 1970, near the University of Pennsylvania. It is a high

    end apparel and furniture manufacturer in the highly fragmented apparel industry. Its

    two main competitors are Abercrombie and Fitch and J Crew. Urban Outfitters has gained

    a competitive advantage over its competitors by implementing a strategy focused on

    product differentiation, brand prestige, and customer loyalty. The parent company has

    been broken down into three separate brands to specifically cater to a different target

    market. They also created a competitive advantage by offering eclectic merchandise and

    a unique retail experience.

    Accounting Analysis

    Firms release financials at their fiscal year end which includes an Income

    Statement, Balance Sheet, and Statement of Cash Flows. The Income Statement is an

    annual measurement of a firms operations. The Balance Sheet is a statement of a firms

    book value of all of the assets and liabilities (including equity) at a particular date. The

    Statement of Cash Flows indicates a firms annual liquidity and takes into consideration

    operating, investing, and financing activities. Firms are allotted generous flexibility in

    regards to accounting for certain expenses. Urban Outfitters has benefited from such

    generosity based on how they account for leases. While investigating their financials, we

    found a $516 million off-balance sheet transaction which was created from operating

    leases ranging from 5-15 years. Firms also are allotted generous flexibility in terms of

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    disclosure. Upon further review of URBNs financials, we were not satisfied with their

    disclosure and rate it average at best.

    To ensure firms are not guilty of accounting irregularities, expense and revenue

    screening diagnostics are implemented. Based on these diagnostics, creditors and current

    and potential investors can identify potential red flags. After conducting these screening

    ratios, there were no indications of accounting irregularities for URBN.

    Financial Ratio Analysis and Forecasting

    Financial ratio analysis consists of a series of ratios that measures a firms

    liquidity, profitability, and capital structure. These ratios illustrate how effective and

    efficient a firms operations are compared to major competitors. As stated above, we

    determined that ANF and JCG would best represent URBNs competition. We also

    conducted an analysis for certain ratios with the lease capitalization inclusion of $516


    Financial forecasting relates to finding certain growth trends amongst major line

    items in a firms financials. We conducted Income Statement, Balance Sheet, and

    Statement of Cash Flows forecasts for URBN thru 2016 based upon these trends. We

    concluded by providing a cost of capital estimation by finding a cost of debt and equity.

    First, Beta was found by running a regression analysis followed by a cost of equity

    estimation. A revised cost of equity had to be found due to the inaccuracy it would cause

    in the intrinsic valuations. We then found our cost of debt by measuring our current and

    long term liabilities by published Moody rates. Moodys is a credit rating agency

    responsible for publishing ratings for business and other entities that reflect the likelihood

    and probability of credit default.

    Intrinsic Valuations

    Four different methods were used in the intrinsic valuation section to determine

    whether the stock price for URBN was undervalued, overvalued, or fairly valued. Every

    method used produced different results and has different explanatory power when

    estimating stock prices. The methods used were: Free Cash Flows, Abnormal Earnings

    Growth, Long-Run ROE Perpetuity, and Residual Income. We believe that the AEG model

    produces the most accurate share price of $17.85 compared to a listed share price of

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    $24.93. Overall, each model found URBN to be a highly overvalued firm. We believe that

    URBN should be valued lower than the observed share price. We recommend selling this

    stock due to a constant intrinsic valuation of each model suggesting this firm is highly


    Company Overview

    Created near the University of Pennsylvania in 1970, URBN has 37 years of

    experience creating and managing retail stores. These stores offer decidedly

    differentiated collections of fashion apparel, accessories and home goods to a highly

    defined market niche. Urban Outfitters is a pioneering lifestyle merchandising

    company that operates specialty retail stores under the Urban Outfitters, Anthropologie

    and Free People brands. Free People is based primarily online. All of these brands are

    higher end products designed for a specific target market.

    Although the apparel industry is highly competitive, Urban Outfitters highly

    defined market niche is best marketed through differentiation, rather than cost

    leadership, in order to achieve their competitive advantage. Examples of such

    differentiation include offering eclectic home furnishings such as tangerine apostrophe

    chairs, velvet sofas, and spectrum chandlers.

    Urban Outfitters relies heavily on the Pareto principle: 20% of customers

    represent 80% of sales. Based upon this, they strive to establish invaluable bonds

    between their targeted customer audience which signifies their dependence to both

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    improving and maintaining brand loyalty. In fact, they place such a significant emphasis

    on image recognition that they have established a separate subsidiary that protects

    against copyright infringement. In the following sections, we delve deeper into URBNs

    operating performance as well as introduce the five forces model.

    Company Performance

    Urban Outfitters has experienced an increase of sales volume from $349 million to