There is some cause for optimism, including agreements with retailers such as DSW and Kohl's.
Shares of Under Armour (NYSE: UAA) have rallied over the past week and now trade at around $22, close to the highest point since early February. The run is likely attributable to the recent outflow of money out of the tech sector and optimism that Under Armour can engineer a turnaround after a number of weak quarterly earnings reports.
There is some reason for optimism: the company's merchandise is now available at Kohl's (NYSE: KSS) and will soon be sold at DSW (NYSE: DSW); the Curry 4 received a positive reception online; and shares are the cheapest they've been in a number of years, leading some to wonder whether or not current levels present a buying opportunity.
Given how drastically Under Armour's stock has fallen over the past couple of years, I am not as bearish as I was when the stock traded in the mid-$40's but I would advise potential investors to exercise caution when it comes to UA. After all, revenue growth has slowed quickly and future growth is contingent upon whether or not the company will be able to maintain growth in footwear, which has struggled as of late.
Footwear
The importance of Under Armour's footwear segment cannot be overstated. After all, it must continue growing quickly in order to offset slowdowns in apparel sales. It is also expected to serve as a long-term driver of revenue growth for the company, and as such its continued acceleration is necessary for the bull case to play out.
However, footwear growth has slowed quite drastically as per this chart:
Footwear Revenues YoY Growth Q1 2016 $264 million 64% Q2 2016 $243 million 58% Q3 2016 $279 million 42% Q4 2016 $228 million 36% Q1 2017 $270 million 2%
This rather sharp slowdown in footwear sales can be attributed to a number of factors: the decline of performance basketball, a trend that has also affected Nike (NYSE: NKE); slow sales of the Curry 3; and the rise of the "athleisure" trend favoring casual, fashion-oriented footwear as opposed to performance gear.
Under Armour's shoes will not gain appreciable market share unless they are able to offer some aesthetic, performance, or cost advantage over shoes from Adidas (OTCQX: OTCQX:ADDYY) or Nike given those two companies' dominance in the footwear industry. I have yet to hear a convincing argument over why Under Armour's shoes are superior to those of its competitors, and this is another reason why I believe footwear sales have been slowing. After all, Adidas struggled in North America until the company started producing fashion-oriented footwear that offered an aesthetic advantage over Nike's.
The Profitability Issue
Under Armour's profitability also appears to be on a downtrend:
Margins 2013 11.4% 2014 11.5% 2015 10.3% 2016 8.7% Q1 2017 0.7%
The chart above lists Under Armour's operating profit margins for the past four years and Q1 2017. Margins have been on a sharp downtrend for the past four years, which means that the company is earning less on each dollar of sales than it did before.
UA's operating margins in Q1 2017 were abysmal at 0.7%, down from 3.4% a year earlier. I would argue that this decrease was due to increased discounting and markdowns in order to move product and maintain sales growth. This trend, if it continues, does not bode well for investors as earnings will continue to contract.
I believe the company has had to increase promotional activity and has had to broaden its distribution network in order to maintain sales growth, which has led to deteriorating margins. For example, Under Armour's recently formed partnerships with Kohl's and DSW are likely to increase revenue growth but won't be good for margins as both companies are discount chains.
Under Armour needs to ensure that it doesn't erode the premium quality and perception of its brand, which is important for profits and brand image. Ralph Lauren (NYSE: RL) is a good example of a company whose share price suffered due to increased discounting and lower margins.
Regional Differences in Popularity
In past articles, I've made the argument that Under Armour is less popular than both Nike and Adidas in urban areas and the west coast. This thesis is supported by Google Trends data: California, New York, and New Jersey are the top three states in terms of search interest for Adidas and Nike, whereas Maryland, South Dakota, and North Dakota are the top three states that search for Under Armour.
New York is 41st on the list of states that search the most for Under Armour whereas California is dead last. This observation accounts in part for Under Armour's recent weakness in North America, which accounts for the bulk of its revenues.
Under Armour needs to do a better job of creating products that are both fashionable and performance-oriented in order to appeal to a broader swath of consumers. Plank admitted as much on the Q4 2016 earnings call, and it remains to be seen whether or not the company will be able to accomplish this.
Valuation
Under Armour remains relatively expensive when compared to its peers, as per the below industry comparison chart:
Its PE multiple of 57 and PS ratio of 1.9 appear too high for a company whose revenues and profitability have been on a sharp downtrend. The company needs to reverse the downtrend in operating margin in order to contract the PE ratio and present a better investment to potential investors.
Positives
The bull case is supported by some recent positive developments. The Curry 4 received a warm reception on social media and traditional news outlets due to its aesthetically appealing design, which provides some optimism that the company will be able to turn around its image as a maker of bland performance gear.
Steph Curry also continues to shine, having just won his second NBA championship in three years. He is UA's most prominent endorser and one of the factors that has led to UA's success in past years; as such, his continued popularity and performance are important to Under Armour's future.
Partnerships with retailers like DSW and Kohl's should increase the company's revenues in the long-run and puts the company in a better position to compete with its larger rivals.
International growth has also remained solid, which should be another potential long-term catalyst for Under Armour if it continues:
International Revenues YoY Growth Q1 2016 $149 million 56% Q2 2016 $150 million 68% Q3 2016 $226 million 74% Q4 2016 $215 million 55% Q1 2017 $227 million 52%
Conclusion
A long position in Under Armour does not appear justified at the moment since the company's future is based on several unknowns, including whether or not footwear growth can continue, the company can reverse the downtrend in profitability, etc.
UA's performance in recent quarters has been lackluster and I would advise potential shareholders to wait before buying shares of the company. While shares have tumbled in recent months, UA still appears expensive on a fundamental basis.
I will keep readers updated via articles on this site and am always welcome to any questions or disagreements either in the comments section or via email (email address is in my Seeking Alpha bio). Thanks for reading!
Disclosure: I am/we are long ADDYY.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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