Under Armour (UA, Financial) is one of very few companies that can boast of growing its revenues 10 times in the last 10 years.
From a mere $431 million sales in 2006, Under Armour sales reached $3.96 billion as of 2015, and the company wants to reach $7.5 billion by 2018 – more than 10 times what the company sold in 2008.
When you have that kind of growth, it's natural for the stock price to follow. Believe it or not, Under Armour’s stock price has also grown exactly 10 times between 2006 and 2016, from around $4 in August 2006 to the current $42 levels.
The biggest problem investors face when we have a hyper-growth company is trying to figure out how much they are ready to pay for that growth. Under Armour is now trading at 53.8 times forward earnings and 106 times earnings. On the price-sales (P/S) ratio front the company is trading at 4.1 times sales compared to three times sales for big brother Nike (NKE, Financial).
The difference between Nike and Under Armour
With Nike, the story is different because, while it's chasing a big goal of $50 billion in sales, it's a more mature company with a much larger footprint and a dominant position in the sports footwear space. For Nike it’s more a question of fighting macroeconomic headwinds and getting stronger brand returns in basketball. I’ve written about that in detail: Why Nike May Not Reach Their Goal by 2020.
Under Armour, on the other hand, is still in the early stages of growth. That explains the high expectation and the resulting valuation. But the challenge Under Armour now faces is that multiplying a top line of billions isn’t the same as multiplying millions the way it did over the past 10 years. What that means is that valuation will come down as growth slows and Under Armour finds a growth pace it can sustain for another decade.
It’s like the Olympics in a way. Until now Under Armour has been running the 100-meter sprint, but now it has to prepare itself for a marathon that will take it well into the next decade. As that starts to happen, we’ll see its price-sales ratio converging with that of market leader Nike. Perhaps slightly better if it can tap into its strength in the apparel market, but we’ll pretty much see a mirror image of Nike in Under Armour’s metrics.
The pros and cons at UA
But all’s not well with the company, which is now trading nearly 20% lower than its 52-week high of $52.94. Its bane has been the string of bad news that’s been coming its way over the past six months. Net profit plunged 58% due to the impact of the liquidation of its top seller Sports Authority, and the 28% year-over-year sales increase did nothing to help. Not even reiterating its guidance of 24% growth for the year helped its stock price, which plummeted shortly after the earnings call. To make matters worse, its golf ambassador Jordan Spieth had a meltdown when the Masters title was within his sights, and the company saw its women’s division gradually slipping through its fingers.
On the positive side, however, overall sales growth continues unabated, remaining well above the 20% level. As such, the company is still seeing the remnants of growth that it enjoyed over the past 10 years. Considering the fragmented nature of the multibillion-dollar footwear and apparel markets and even Nike expecting 10%-plus growth over the next few years, there’s plenty of room for Under Armour to grow.
Was its performance deserving of a 20% stock price decline?
The real opportunity for new investors and investors looking to add to their Under Armour positions is the reaction of the market. Despite considerable market potential, a near-30% sales growth and a guidance that remains intact for the full fiscal, the stock was hammered down before slowly attempting to limp back to normalcy.
As a company, Under Armour will continue to face challenges, but the market has obviously failed to realized this. Instead of supporting the company in times of temporary crises, some investors dropped the stock like a hot potato and ran for cover. And that is exactly what separates the long-term value investors from those who want to make big money in a short period.
The things that happened to Under Armour over the past few months is no reason for the stock to take such a big hit, but that’s exactly what happened.
My take
That said, now is the time for value investors to load up on Under Armour. Its 20%-plus growth will continue for at least the next five years because there are several untapped opportunities that it has yet to explore. The road ahead is wide open, and that $7.5 billion revenue target might well be achieved before 2018 if its sales growth holds its current levels until that time.
From another perspective, if Under Armour were to have Nike’s P/S valuation the company would be worth $23.25 billion – that’s 25% more than the $18.6 billion that it's currently valued and very close to its 52-week high.
Thanks to the price drop Under Armour seems like an attractive investment now, but don’t forget that with a 4X sales multiple there’s no margin of safety. Any bit of bad news can still send the stock spiraling down while exceeding its guidance will act as a balance of sorts.
The stock will be volatile for as long as Under Armour remains a hyper-growth story, which will continue for the next half decade at least. To invest, either use a DCA approach to build into a position or buy in the dips; and if you currently hold the stock, don’t lose sight of the fact that this trip will take you to the top, but it’s going to be a roller-coaster ride, to put it mildly.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
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