Urban Outfitters (URBN) Rally Has Gone Too Far, Too Fast

The shopping preferences of the American consumer have been shifting for a number of years now. Online sales have been growing and sales at shopping malls have been on the decline.

Many traditional shopping malls have closed or they are struggling to bring people through the doors. This shift was going on well before the pandemic, but the global health crisis may have accelerated the demise of many shopping malls.

Retailers who maintain their stores in traditional malls have struggled to grow earnings and sales in recent years. One such retailer is Urban Outfitters (URBN).

Over the last three years the company’s revenue has only grown by 2% per year while earnings have declined. In the most recent quarterly report revenue was down 17% and earnings were down 43% compared to the second quarter of 2019.

Urban Outfitters’ management efficiency measurements are below average. The return on equity is 13.4% and the profit margin is only 6.7%.

When you combine the lack of earnings and revenue growth with the low ROE and profit margin, it shows that the overall fundamental picture for the company is bleak compared to other companies.

Resistance looming in the $25 area

Urban Outfitters has been trending lower for a couple of years now. The stock peaked at an all-time high of $52.50 back in August ’18 and in the March meltdown the stock dropped to a low of $12.28.

What concerns me is that the stock has rallied sharply off of that March low and more than doubled at its August high.

What jumped out at me on the chart was how the high from August connected with the highs from April and November of 2019. This downward sloped trend line is now just above the $25 level and will drop down to that level in the next week or two. Urban Outfitters is scheduled to report earnings on November 23.

Another thing that stands out is how the stock fell from November ’18 through March ’19 and again from November ’19 through March ’20. This could be pointing to a seasonal pattern in the stock.

The first decline saw the stock drop over 33% and the second one saw the stock fall over 60%. Yes the second one was probably made worse by the overall market meltdown, but it fell almost 24% in the week of November 18, 2019.

Based on the downward trend and the looming resistance, I like the idea of buying puts on Urban Outfitters. Given the two big declines I mentioned above, I like the idea of going out to the March 2021 options.

I think the 27-strike puts give investors the best risk-reward relationship. The March 27-strike puts are currently priced at $5.40, or $540 each. The stock is currently trading at $24.42.

If the stock does in fact peak in the $25 area and falls 33% again, this would take the stock down to $16.75. If the stock drops that low, the options will be worth $10.25 at the very least and that would mean a 90% gain for investors.

By going up to the $27 strike, it also allows some leeway for the stock to move above the $25 level without causing a big drop in the option price. Should the stock move above the $26.00 level, I would consider shutting the trade down.

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