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Under Armour: Solid Growth Story, but More Visibility Needed

Under Armour [UA: 21.22, -3.72 (-14.92%)] is one of the lead developers and distributors of branded performance apparel, footwear and accessories for all types of athletes. They produce products in three main segments: Apparel, which includes their blockbuster shirts that are developed to keep the body cool during extreme conditions; Footwear, which consists of cleats for football, baseball and softball, but has some great growth prospects; and other products, such as gloves for football and baseball. The company has gained market share in these regions at an alarming pace over their past few years due to their synthetic fabrics that are designed to keep perspiration away from the skin to help regulate body temperature. They do operate in a very competitive environment, with some well developed competitors such as Nike [NKE: 44.37, -1.30 (-2.85%)]. Under Armour can be considered one of the biggest growth stories, but has to be approached with caution in the near term.

Long Term Fundamentals

As I said, this company has some very impressive long term growth fundamentals that should drive profits well past 2009:

1. Performance Training Footwear Launch
2. Strong Marketing Strategy
3. Strong Possibility of Gaining International Market Share
4. Increased Segment Growth & Market Share Gain

1. Performance Training Footwear Launch: On May 3rd, 2008 Under Armour launched their Performance Training Footwear, with the slogan “Stop Training in Running Shoes”, in order to gain an even larger market share of the $9.5 billion footwear industry. The company is banking on the fact that people will turn to their products as they offer superior comfort with their synthetic fiber technologies, most notable in a footwear backlog of 1 million units. This represents a significant opportunity for UA to cement their place in the cross training industry, as one of the top producers of athletic shoes that can be used in a vast number of situations for virtually any consumer. With their plan to continually open up more stores and strong growth in their online business, I see no reason why this business will not thrive well into the future and open up more opportunities for UA to produce more products in the future.

2. Strong Marketing Strategy: I personally love Under Armour’s marketing strategy, especially for a relatively new company they know how to get their name out into the market. They frequently sponsor events in the market that they serve, such as the Under Armour High School All-American Football Game and Under Armour Senior Bowl. They also sponsor various colleges teams, such as Texas Tech University, providing all their equipment for national publicity. Not only that, they also go out on the road to NFL facilities and other large cities to test their products and act on the feedback. Last but not least, everyone loves their commercials and catchy slogans, such as “Click-Clack” and “We Must Protect This House.” I don’t know about you but they sure do get me pumped up for athletic events and makes me want to check out what they have to offer.

3. Strong Possibility of Gaining International Market Share: Currently 95% of Under Armour’s sales and revenues come from the United States. The good thing about this, is that there is significant opportunity for UA to expand internationally, which they have been doing. They have announced signings with the World’s Rugby Union & Hannover 96 (a German soccer league). This gives them at least an entry point into the two key international markets of UK and Germany. With the establishment of an international unit headed up by Peter Mahrer, a former Puma executive who increased international revenues fourfold in six years, the ability for UA to penetrate international markets looks very promising in the long term as they continue to gather information on trends and feedback in these regions about their products.

4. Increased Segment Growth & Market Share Gain: During the 1Q08, UA posted significant segment growth within their apparel division. Overall it grew by 25%, with the Men’s division up 20%, Youth up 29% and Women’s up 36%. They also reiterated their full year growth targets of 26-28% for the division. Also very encouraging was their strong growth in the direct-to-consumer line of business (online business, call centers & their branded retail store), which grew at a pace of 77%, well over company estimates of 50%. They noted that their main consumer base, the youth, do a lot of shopping online, which is why they were able to achieve such high growth in this area. This also highlights their strong marketing strategy, as they are aware of who their consumers are and how they shop for goods. They also have posted strong market share gains in the active use apparel industry. In terms of total active use they are 2nd to only Nike, overtaking Adidas, with a market share of 13.9% and they lead the men’s active use with a market share of 18.8%, with their Youth and Women’s division expected to grow significantly.

Short Term Concerns:

While there are many positive long term fundamentals for Under Armour, there are some short term concerns that may hold UA back for one or two more quarters.

1. Lack of Visibility in International Growth and Future Products
2. Likelihood of Consumer Recession in the US
3. Margin Pressure, Higher Inventories & Higher Marketing Costs

1. Lack of Visibility in International Growth and Future Products: The company failed to provide any type of visibility for the possibility of international growth, simply because they have just recently entered these markets. That being said there is no guarantee of success, which would pose a problem since 95% of their revenues come from the United States. The launch of their Performance Training Footwear, also hinders the company’s ability to forecast future products, as they will depend on the success of this launch, to generate new products at the end of 2008.

2. Likelihood of Consumer Recession in US: With over 90% of the stimulus checks distributed, US consumers will find themselves struggling to find extra income to spend on discretionary goods, which will definitely affect the bottom line for UA negatively. There is a strong possibility that there could be a full blown consumer recession, much like the one in the 70’s, which would really hurt UA as they have yet to develop a strong market share in international markets.

3. Margin Pressure, Higher Inventories & Higher Marketing Costs: In the last quarter the company’s gross margin decreased by 110 basis points to 47.6%, due mainly to higher marketing and SG&A (Selling General & Administrative) costs, most of which was related to the launch of the Performance Footwear line. I expect higher marketing costs to continue to weigh on margins, in an already low margin industry, as UA tries to promote their brands and move into new markets and products. They also noted higher petroleum costs as one of their risk factors and the rise in commodity prices will not help them out. It is important to note that they have locked in most of their prices for 2008, but 2009 remains questionable. Under Armor had higher than expected inventories last quarter, mainly due to a high inventory in baseball and football gloves, which hurt their bottom line as they overestimated seasonal demand and the lack of availability of those products in retail stores due to the season. Yet with this in mind, the company said they do not expect this to be a problem in the future.

Valuation

P/E (ttm): 33.64x
Forward P/E: 18.97x
5 year EPS Growth: 65.63%
Operating Margin: 11.65%
Current Ratio: 3.82x

From a valuation standpoint, UA’s multiples are a little higher than the industry average due to high anticipated growth rates. I personally think that they are fairly valued and should stay around this range ($26-30), until there is greater visibility from international growth and their Performance Footwear launch. It is also important to note that they are expected to report EPS for 2Q08 of $0.01, which would technically decrease their TTM EPS, weighing on shares in the short term, although they do have a history of beating expectations.

Recommendation

While UA definitely has strong growth prospects, I think the high possibility of a U.S. consumer recession along with deteriorating conditions in the UK will weigh on the profitability of Under Armour in coming quarters. I think that the successful launch of their Performance Footwear line should partially offset the short term concerns highlighted above, but would expect them to report in-line or just below estimates given the tough economic environment they faced in the 2Q08, with rising commodity prices and decreased discretionary spending.

For those who currently own the stock I would hold your position, but for those looking to buy in I would remain a little cautious and look for more visibility from the earnings conference call on July 29th. There could be downward pressure after earnings if things are not up to par, which I think would create a buying opportunity at the right time (below $25). But with the recent run up in the shares, I would wait before building a new position and look for the company’s comments on operating performance in this tough environment and future expectations of performance.

-Vinay Ayala

Disclosure: The mutual fund that the author is associated with is long NKE

The Following Stocks Were Mentioned In This Article: NKE, UA

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