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The Science of Hitting
The Science of Hitting
Articles (710) 

Under Armour: Encouraging Signs of Improvement

A look at the company's third quarter financial results

November 03, 2020 | About:

Last week, Under Armour (NYSE:UA)(NYSE:UAA) reported results for the third quarter of fiscal 2020.

Revenues in the quarter were flat year-over-year at $1.4 billion, a meaningful improvement from the 41% decline reported in the second quarter. Based on management's guidance, the company now expects revenues to decline by roughly 10% in the second half of the year, compared to the 20% to 25% decline that they guided to three months ago.

The outperformance relative to prior expectations was due to a 5% decline in North America, along with high-teens growth in the International businesses. By channel, direct-to-consumer revenues increased 17% in the quarter to $540 million (with e-commerce up more than 50%), offset by a 7% contraction in Wholesale revenues to $830 million.

The better-than-expected results, particularly in North America, led to an improvement in the company's inventory position: at the end of the third quarter, Under Armour held $1.1 billion in inventories (+17% year-over-year) compared to $1.2 billion at the end of the second quarter (+24% year-over-year). That said, management still expects industry overhangs to have an impact during the holiday season: as noted by Chief Financial Officer David Bergman, "we do think that the promotional environment is going to be pretty heavy this quarter, a fair amount heavier than it was in the third quarter."

Gross margins in the quarter declined by 40 basis points to 47.9%, with headwinds from pricing and discounting offset by supply chain benefits and channel mix (less off-price, more direct-to-consumer). Selling, general and administrative expenses were unchanged from the year ago period, resulting in 40 basis points of operating margin contraction to 9.3%. As a result, adjusted operating income in the quarter declined by 4% to $133 billion.

At quarter end, the company held $866 billion in cash and equivalents compared to just under $1 billion in long-term debt. As I noted last quarter, Under Armour has taken steps to shore up its financial position – a primary focus for the company given the recent struggles in the business. They took another step in that direction in the third quarter, announcing the sale of MyFitnessPal for $345 million (the deal is expected to close in the fourth quarter).

The company's foray into this space has proven underwhelming. In 2015, the company paid $475 million to acquire MyFitnessPal and Endomondo. Over the five year period through 2019, the Connected Fitness business has reported roughly $70 million in cumulative operating losses. As founder and former CEO Kevin Plank noted when the deals were announced in 2015, "We are developing a digital ecosystem that provides us with unparalleled data… [that will help us become] more relevant to how the consumer shops for our brand." In hindsight, it does not appear that those assets actually helped Under Armour further its primary objectives (to sell more shirts and shoes).

For the year, management expects revenues to decline by nearly 20%. While that's clearly a disappointing outcome for the year, it's a meaningful improvement from the more than 30% decline in revenues that it reported in the first half of the fiscal year. As shown below, the company is on pace to report roughly $4.3 billion in revenues for the year, lower than in each of the past four years.

Conclusion

It has been an interesting couple of years from Under Armour. After reporting years of more than 20% revenue growth, the company reported low-single-digit top-line growth from 2017 to 2019 as they worked to turn around and transform the business. In 2020, they've been sideswiped by the pandemic, which put incredible pressure on the business over the past six months.

But while the results in the past few years have been lackluster, I think there are reasons for optimism as we look to the future. First, the decision to sell MyFitnessPal reflects renewed focus on the core business, and the proceeds from the sale will improve the company's financial position. Second, following in the footsteps of industry leader Nike (NYSE:NKE), Under Armour has indicated they will reduce their reliance on undifferentiated retail, with the expectation that they'll reduce the number of doors in North America by roughly 20% over the next two years. Finally, management has voiced a clear focus on strengthening the company's direct-to-consumer business, while reducing their reliance on the off-price channel. All-in-all, I think these moves can make the brand, and the business, stronger over the next few years.

As some of you may remember, I owned Under Armour a few years ago. I believed the level of pessimism attributed to the company by Mr. Market was excessive, and managed to get out of the investment with good returns (granted, if I had held the stock until today it would have been less rewarding, so maybe it's more appropriate to call that a lucky trade than a good investment).

Today, I feel like the story mirrors the situation I was looking at a few years ago. I don't have any plans to purchase shares of Under Armour at this time, but that may change in the coming quarters if I like what I see (and the stock doesn't move higher).

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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