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The Science of Hitting
The Science of Hitting
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Under Armour: A Tough Start to 2020

A look at the company's first quarter financial results

May 24, 2020 | About:

Earlier this month, Under Armour (NYSE:UA)(UAA) reported financial results for the first quarter of fiscal 2020. Revenues in the period declined by 23% year-over-year to $930 million on weakness in apparel and footwear, with Wholesale declining 28% to $592 million and Direct-to-Consumer (DTC) falling 14% to $284 million. Note that the double-digit decline in DTC occurred despite a nearly 30% increase in owned doors count over the past year.

Even though North America was expected to have a tough quarter, it was much worse than anticipated, with revenues in the region falling by nearly 30% to $609 million. To put that in context, Adidas' North American revenues in the quarter ended March 31 increased by 4%. As those numbers suggest, UA is having a tough time, particularly relative to its largest competitors. The International business struggled as well, with revenues declining 12% to $287 million.

Against the 23% decline in revenues, inventories increased mid-single digits to $940 million. In addition, as mentioned on the conference call, this is likely to worsen in the second quarter. This is a problem for a few reasons. First, inventories consume a fair amount of capital during a period where Under Armour is in need of liquidity. Second, excess inventories will require the company to discount merchandise (and continue to rely on off-price channels) in the coming quarters. Third, Under Armour probably isn’t the only company in that position, which could impact competitive behavior (as noted on the call, this is likely to cause “a very promotional environment through the rest of the year"). Finally, the company’s outsized inventory position, along with some liquidity concerns, will likely constrain their ability to aggressively commit to product buys for the second half of the year.

It’s worth noting that the lackluster results reported in the first quarter included only a few weeks of disruption in North America. Stores were closed in mid-March, which management estimates accounted for roughly half of the year-over-year decline in the region. The second quarter results, on the other hand, will include a larger impact from closures. When results were reported on May 11, substantially all of the company’s stores and those of retail partners remained closed. The e-commerce business may provide some offset during this period, but it only accounts for a low-double digit percentage of UA's revenues. For that reason, management believes second quarter revenues could decline by 50% - 60%, implying that the first half of 2020 revenues will be around $1.5 billion – down by roughly 40% compared to the first half 2019.

Given the severity of these declines, management is working quickly to adjust the cost structure and conserve liquidity. This includes a significant reduction in marketing spend, lower employee costs (via layoffs), a cut to capital expenditures and extended payment terms with vendors.

At quarter's end, the company had $960 million in cash and equivalents compared to nearly $1.2 billion in total debt. That figure includes $600 million drawn under the company’s credit facility, with the company drawing an additional $100 million in early April. This week, the company announced that they raised another $440 million through convertible notes. The meaningful actions taken as of late to shore up the balance sheet reflect the strain they're feeling. In my opinion, until we see a meaningful change in business trends, Under Armour is not in a position to truly play offense - and given that they’re pulling back on marketing in the face of a difficult macroeconomic environment, it seems unlikely that an improvement in brand momentum will materialize anytime soon.

As a result of the significant decline in revenues and an inability to materially change the cost structure in the short-term, Under Armour reported an adjusted net loss of $152 million in the quarter (or $0.34 per share) compared to $22 million in net income in the year ago period.

Conclusion

I've followed Under Armour for many years and used to own the stock. I got lucky that Mr. Market became overly optimistic in 2018 and 2019, presenting a chance to sell at a nice gain.

In the right situation, it’s a company I would own again. That said, I don’t think that time is now. As CEO Patrik Frisk noted on the call, "there will be a number of challenges ahead of us... a slow and progressive return to normalization, a highly promotional environment, and significant uncertainty in brick-and-mortar traffic and conversion as consumers return to stores."

Personally, this is as dire as a scenario that I've seen for Under Armour. While the short-term results have been materially impacted by the pandemic, the stark reality is that they are now trailing industry leaders Nike (NYSE:NKE) and Adidas by a wide margin. Said differently, you cannot blame all of their current struggles on exogneous factors. Given that the company’s focus in the short-term will be stabilization and survival, I’m not sure we’ll see the gap close in the near future either.

For that reason, despite a stock price that is well below where the equity has traded in recent years, I’m going to stay on the sidelines for now. I need to see signs of improvement before I would consider investing in Under Armour again, along with a stronger belief that the margin profile attained in the decade following the company's IPO is still achievable.

Disclosure: None

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About the author:

The Science of Hitting
I desire to own high-quality businesses for the long-term. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with the top five positions accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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