Over the past year, Under Armour (UA)(UAA) stock has declined by more than 50%. Most of the real pain has occurred over the past six months – specifically, after the company reported financial results for the third and fourth quarters. Let’s take a quick look at each of them.
On the third-quarter conference call, management abandoned its 2018 operating income target of $800 million (set at the 2015 Investor Day). Considering this target had been set only 12 months earlier, it was a big negative surprise for the market. The stock fell 13% on the news.
But that was peanuts compared to the fourth quarter: Under Armour announced sales growth for the holiday period of 12% – or less than half of the 26% growth rate reported through the first nine months of 2016. Guidance for 2017 implied growth in the low teens – well below the 20%-plus revenue growth rate investors have come to expect. In addition to pulling the profit guidance, investors now believe top-line estimates will prove far too optimistic as well. The stock fell 26% on the news.
For the first time in years, the market appears somewhat skeptical about Under Armour’s prospects.
I first looked at Under Armour after the third-quarter results. My conclusion was the valuation was still too optimistic for my blood. After another big move south following the fourth quarter, that’s starting to change; as a result, I’ve slowly started buying some Under Armour shares.
The long-term case for Under Armour
Under Armour sold its first product – a compression shirt – in 1996. Over the past two decades, Under Armour has evolved from selling a single product to a head-to-toe athletic sports brand with 2016 revenues of nearly $5 billion. Despite Under Armour’s astounding top-line growth over the past 21 years, the business mix still largely reflects its roots: apparel accounted for two-thirds of revenues in 2016; the U.S. accounted for an even higher percentage, at 85% (Under Armour still has roughly half as many points of distribution in the U.S. as key competitors Nike [NKE] and Adidas [ADS][ADDYY]).
That’s not for lack of growth in other areas. For example, the apparel business, at $3.2 billion in 2016, has nearly tripled its annual sales over the past five years. Over that same period, Under Armour has expanded its focus into new product lines – most notably, footwear. From less than $200 million in sales in 2011, Under Armour’s footwear business crossed $1 billion for the first time in 2016 (~20% of sales).
While growth has ramped up over the past few years (with revenues up 50% in 2016), this has been a long time coming; the company has taken the long view, starting with the launch of football cleats in 2006 (along with the memorable “click clack” marketing campaign). This was followed by baseball cleats in 2007, running shoes in 2009 and basketball shoes in 2010. For years, success was largely confined to cleats (a decade after launch, Under Armour had roughly 40% market share in football cleats); that's starting to change due to recent success in basketball.
We see a similar story in the International business. From less than $100 million in 2011, the company’s non-U.S. sales were just shy of three-quarters of $1 billion in 2016 (with management targeting $1 billion in 2017). As I noted above, Under Armour still generates more than 80% of its revenues from the U.S.; by comparison, the U.S. accounts for less than 50% of Nike’s revenues (according to Barron’s, the U.S. accounts for roughly one-third of the global sportswear market). While it’s early, and there will be hiccups along the road, international markets are a significant long-term opportunity for Under Armour.
One of the primary drivers of Under Armour’s weak fourth-quarter results was issues in the North American retail channel. While some are focused on the short-term headwinds related to this transition, my eyes are looking at the opportunity this presents for the company in the years to come. In 2016, Under Armour’s direct-to-consumer (DTC) business, which consists of flagship stores, outlets and online sales, accounted for nearly one-third of the company’s business. In the holiday quarter, when the overall business grew 12%, DTC increased 23% (and accounted for 40% of revenues). Having a direct relationship with consumers – in the stores and online – is important as the retail landscape evolves; it’s a major reason I’m comfortable owning the stock.
Conclusion
Where this becomes more difficult for a value investor like myself is on valuation. At the current stock price of ~$18 per share (nonvoting shares), Under Armour’s market cap is roughly $8 billion.
My model (more appropriate to call it a reverse DCF) implies revenue growth from 2018 to 2020 in the high teens (after 12% in 2017). The other major assumption in the model is an increase in pretax margins to the high single digits over time (compared to ~5% in 2017); this conclusion is based on Under Armour’s own historic results as well as the experience of other players in the industry.
The specific numbers are less important than what I’m broadly saying by accepting those assumptions. Under Armour is a unique brand, and the success of the past 20 years is not a fluke; while the company’s current struggles may last for some time (excess inventories won’t help), it does not foreshadow permanent decline. I should note my investment does not include any assumptions for “connected fitness,” which is a bit of a wild card in my mind.
Even relative to normalized earnings power, the stock doesn’t appear to be a screaming bargain (by my math it’s somewhere in the range of 20x pretax earnings). You could probably make a reasonable argument I’m stretching a bit on this one; I’m comfortable being early. My hope is Under Armour falls further so I can make it a larger position at a more attractive valuation.
As always, I look forward to your thoughts.
Disclosure: Long Under Armour.
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