Under Armour – Chasing Down Nike

UA store

Overview:

Under Armour, Inc. develops, markets and distributes branded performance apparel, footwear and accessories for men, women and kids. The Company’s segments include North America, consisting of the United States and Canada; Europe, the Middle East and Africa (EMEA); Asia-Pacific; Latin America, and Connected Fitness. Its apparel is offered in various styles and fits to improve comfort and mobility, regulate body temperature and improve performance. UA’s footwear offerings include football, baseball, lacrosse, softball and soccer cleats, running, basketball and outdoor footwear. Its accessories primarily include the sale of headwear, bags and gloves. Its accessories include HEATGEAR and COLDGEAR technologies. It offers digital fitness platform licenses and subscriptions, along with digital advertising through its MapMyFitness, MyFitnessPal, Endomondo and UA Record applications.

Under Armour is the first company that has been able to give Nike a run for its money. UA has already made tremendous strides into basketball and football. Two sports that have always been dominated by Nike. Over the last few years we have seen numerous big colleges switch from Nike to Under Armour. Last year the University of Texas’ Nike contract was up for renewal and as soon as rumors started spreading that UA was interested, Nike re-signed Texas to a massive 15 year $250 million contract.

Under Armour is run by founder and CEO Kevin Plank. He started the business after finishing playing college football with the idea of creating a microfiber t-shirt to replace the heavy cotton ones in use at the time. Today, most football players wear microfiber instead of cotton t-shirts. In its first year, UA had $17,000 in sales. The Company forecasts that it will have $7 billion in 2018.

Footwear Market

The global footwear market is a $275 billion market. Of this market, the athletic footwear portion of the market is $63 billion. This portion of the market is expected to grow at a 3.6% CAGR over the next decade. The athletic footwear market includes sportswear, trekking shoes, aerobics shoes, walking shoes, and running shoes. The initiative regarding healthy lifestyle that motivates people to engage into some kind of sports activity will drive the industry in the coming years. This has motivated leading brands to come up with innovative and comfortable sports footwear products. Growth in wholesale and retail business, efficient supply chain, consumers’ willingness and increased purchasing power have fueled the global athletic footwear market.

The athletic footwear market is very different than the overall global footwear market from a demographic perspective. Men account for 60% of athletic footwear sales and women account for 25% (Children 15%). In the overall footwear market, women account for 57% and men hold 26%. Today, women are buying more athletic footwear and companies are fighting for this market share. In 2005, women only accounted for 21% of the athletic footwear market. Men have continued to spend on shoes but women have grown their share at a faster pace.

The majority of men select an athletic brand of shoe as their footwear preference. The largest brands in this space include Nike, Vans, Adidas, Converse, Puma, and UA. Footwear sales has been a major initiative for UA and it now accounts for 20% of sales as they steal market share. This trend has been led by basketball where UA has 20% of the market. This is up from 16% of the market in the fall of 2015. Steph Curry is driving growth in basketball and he has been a terrific ambassador of the brand.

Footwear

Asia has been a particularly strong market for Under Armour. Asia now accounts for 40% of all athletic footwear sales and is expected to be the fastest growing global market over the next five years. Steph Curry completed his second Asia tour last month in an effort to build his Curry shoe line. The Curry 3.0 was just released and has high expectations.

Under Armour has a mere 1% penetration into the $63 billion dollar market. Nike has a lot to lose. UA is in the first inning of their footwear campaign and they have great products. The future in UA footwear is driven by the Curry franchise. In 2015, Jordan shoes brought in over $2 billion in sales. UA is looking to develop a multi-billion basketball franchise like Nike has with Jordan. Today, Nike is building LeBron’s franchise and it is going head to head with the Curry franchise. Basketball will be crucial for UA to penetrate as football is being viewed as being increasingly dangerous and responsible for long term health problems in athletes. As more research is performed in the next decade, we will likely see more athletes choose basketball over football if they are gifted enough to choose.

Under Armour is working on incorporating technology into the footwear space. At this year’s CES conference they introduced a shoe with an embedded chip that collects data. The data will be used by Under Armour to communicate to consumers when they need to purchase a new shoe. Their data thus far has indicated that when people have run more than 450 miles, there is a higher risk of injury with old shoes. This type of information will be beneficial for the health of UA consumers.

Under Armour Sportswear Line (UAS)

Last month the Company launched UAS. This is very different market for them. UA believes that it has not been servicing the total addressable market. They have noted that about one third of their key competitor’s sales are derived from lifestyle rather than a pure traditional performance product. The lifestyle product provides a halo effect to the other lines of the business. As such, they have decided to fill this product gap with Under Armour Sportswear (UAS). UAS will initially be offered in a limited number of domestic locations including the SoHo (in NYC) and Chicago Brand House venues, as well as Barneys and online retailer Mr. Porter. The new line should be available in Boston in the coming weeks.

The UAS is geared towards trendy millennials. It is combination of traditional UA performance product with more fashion. The collection has a performance component, with stretch and waterproof fabric’s but has a fashionable look. The collection also offers fashionable footwear. The women’s shoe is not a traditional UA sneaker in that it has some lift in the sole. They are also going after the fashionable boot consumer with this line. Most of the products in this new line are priced in the $129-$250 except for the t-shirts, they are priced in the $49-$89 range.

This collection will not have a material impact to the top line until 2018 at the earliest. As they learn and receive feedback they will expand the breadth of the product and distribution. CEO Kevin Plank has said that UAS is a $15 billion opportunity. In my opinion, this is a very optimistic target and it will take many years to scale. Last year, UA had revenues of $4 billion so there is a chance that it might begin to impact the FY’17 revenues.

Under Armour believes that they will successfully be able to convert existing male customers to buy the UAS product. The new collection will not compete with the existing performance products so there will be no cannibalization. While there is an existing male customer base, UA expects the esthetics on the women’s side to attract female customers. Under Armour has traditionally struggled on the women’s side. It is estimated that only 15% of UA’s revenues are generated by female customers versus 23% at Nike.

Female Customer Base

As previously mentioned, Under Armour has historically been a bit out of favor with women. However, in July 2014 they launched the “I will what I want” campaign with Misty Copeland. As the campaign continued, UA signed Gisele Bundchen.  The campaign was a tremendous success by driving 28% growth in women’s sales and a 42% increase in traffic to the UA website. Today, the Company continues to try to appeal to female shoppers. UAS is the most recent strategy rolled out to create a larger female customer base. Nike continues to have a better perception among women but Under Armour is seeing improvement.

UA recently signed a distribution contract with the retailer Kohl’s. This is a strategic distribution move in an effort to reach women. Kevin Plank noted “The female consumer is there, she’s shopping and she’s buying. We think there is a big opportunity.” The margin mix for these sales in this channel are expected to be in line with existing sales. Kohl’s sold $3 billion in activewear and accessories last year representing 15% YoY growth. It is estimated that $1 billion of these sales were attributed to Nike. Under Armour is now offered in all 1,160 Kohl’s stores. This new distribution channel will be a long term revenue source for UA. I have reason to believe that Kohl’s will add $200 million to UA’s top line next year. This new channel alone will generate 350-400 basis points of sales growth in FY17.

International Growth

Under Armour continues to push into international markets and is having tremendous success. In the most recent quarter, international revenues increased by 80% on a constant currency basis. The direct to consumer channel now includes 191 stores comprised of 161 factory houses and 30 brand house stores. The international segment accounts for 15% of total revenues and they are stealing market share from Nike. The strongest international market for UA continues to be China. UA generated as much revenue in Q3 as it did in Q1 and Q2 combined. The brand is growing quickly in and they now have more than 80 stores there.

Intl

As the company expands internationally, they will steal market share from companies in new sports. The growth in EMEA is targeting Nike as well as ADIDAS. UA has not made soccer a growth initiative yet but I expect them to make a run at ADIDAS in soccer in the future. Soccer is the most popular sport in the world and is ranked as the most popular sport among today’s teens. To break into this sport, UA will need to begin signing endorsement deals with young soccer elites. We have seen that one dominant player like Curry or Spieth can really move the needle for UA. Signing the right athlete will be crucial.

Under Armour will be growing internationally for a significant period of time. For a comparison, Nike generated almost $16 billion in international sales last year which is almost 50% of their revenues. Under Armour has yet to reach the $1 billion threshold. I expect them to have $1 billion of international sales in 2018. This will be another important year as it will be an Olympic year. The Olympics provided a boost to international sales in Q3 as a result of an excellent advertising campaign around the Olympics. Under Armour is fairly well known in the U.S but as a brand, it is still in its infancy on an international scale. Worldwide sporting events like FIFA and the Olympics give UA an excellent platform to introduce their brand to the world.

Under Armour has been rolling out their international growth plan and entering new countries. This year alone, they entered into France, Turkey, North Africa, South Africa, Indonesia , Vietnam, Paraguay, and Uruguay. Next year they will enter into Argentina, Eastern Europe, and Russia. UA announced at last year’s investor day that they expected a 50% international CAGR through 2018. Thus far, it looks like they might even exceed that impressive expectation. UA is planning to have operations in over 40 countries by 2018, taking its total international locations to over 800. By the end of 2018, 80% of its global door count would be located outside of the United States, up from 41% currently. Most of the new stores will come via partnerships with distributors, especially in China, Japan, and Korea. UA expects to own and operate only about 30% of the total number of locations worldwide, or about 300. Charlie Maurath is UA’s President of International and he has done a terrific job rolling out their strategy. He has communicated that UA will strive to be the premium brand in every market that it enters. The premium strategy will be consistent regardless of the method that UA exercises to enter a market.

Applications

Under Armour has invested billions into their Connected Fitness strategy. The way that people consume media has dramatically shifted in the last five years from traditional channels like TV to new channels like mobile. The company is using its apps to integrate the brand with users. E-Commerce growth over the next five years will be driven by its MapMyFitness, MyFitnessPal, Endomondo and UA Record applications.

UA also sees strong growth from mobile devices. Mobile traffic grew to 59% of total e-commerce traffic in 2015. That’s up from 5% in 2011 and 28% in 2013. The company is looking to raise mobile traffic fourfold over 2014–18. Total business generated from mobile was up 128% in 2015.

Under Armour’s Connected Fitness platform has over 190 million registered users. Athletic engagement implies more use of its gear and therefore more sales. Going by the current rate, Connected Fitness would have about 385 million registered users by 2018. The Connected Fitness platform allows UA to gain exposure to the $2 trillion food and nutrition market and the $8 trillion health and fitness market. These two markets make the $250 billion sports apparel market look small.

The global wearables market has turned into a battleground for many companies like Fitbit and Apple in recent years. UA is attacking the market from the software side which is probably the only way they can. One in five wearable devices is able to sync to UA’s fitness platform which helps drive sales.

Q3 Earnings Report

The Company surprised investors on their Q3 conference call and updated their long-term guidance. Management indicated that EBIT would be about $200 million lower than they had previously guided. The top line revenue growth guidance was in line with expectations. I believe that half of this $200 million is the result of unfavorable expected currency headwinds and the effects from the Sports Authority liquidation which were not baked into previous guidance. The other half will be used for accelerating infrastructure build, people, and Connected Fitness. I expect CapEx to move towards the 8% mark next year and FCF to swing positive in 2019. I believe the long term growth opportunity in Under Armour remains healthy.

In Q3, UA saw footwear up 48% Y/Y and international was up 74%. These two drivers remain key focal points going forward. In fact, management indicated that during the back-to-school timeframe UA’s footwear market share nearly doubled. In addition, management highlighted that while they sold 30MM pairs of shoes last year, they anticipate selling 40M pairs this year-still well below the 500M pairs that Nike sells. During the quarter, running was highlighted for footwear and the Company has continued to make inroads with women’s footwear. In basketball, the Curry 3.0 were released two weeks ago. This follows the tour that CEO Kevin Plank and Steph Curry made through Asia in September.

Valuation

So how much do you have to pay for all of this? In short, a lot. This is another one of these story stocks that you have to pay up for to get involved. However,the valuation has come down quite a bit since the stock dipped after their Q3 miss. The question is, what is a fair price for the Company?

IS Estimate Pic

IS Product Estimate Pic

After this most recent pull-back, shares are trading at 46x next year’s reset number and about 40x my FY18 estimate. Historically, shares of UA have traded at an average three-year forward P/E multiple of 59.3x (peak: 73x; trough: 40.1x). Since the Q3 miss, the P/E has been more in focus vs. P/S (given that earnings are revised down with higher investment). On a P/S basis, UA is trading at 2.5x FY’17 estimates. Historically, shares have traded at an average three-year average forward P/S of 3.4x (peak: 4.2x; trough: 2.5x). Today the shares are trading at the trough P/S valuation.

Conclusion

UA is a terrific business and a great story. However, the valuation is difficult for me to get comfortable with. The stock may go much higher from here but I can’t buy UA at 46x forward earnings. There is too much risk if the Company were to guide down again. The expensive valuation is pricing in continued robust growth in athleisure. Short seller Jim Chanos believes that athleisure is a bubble. He might be right, he might be wrong. I know there are some value guys that are buying the stock right here. However, if growth in athleisure slows, you do want to be stuck in a stock that trades at 46x forward earnings. I would love to own this name at a more reasonable valuation.

Disclosure


 

No Position