Under Armour (NYSE:UA) is a very interesting company that continues to mature. The stock is down about 35% from its high back in September. Under Armour is run by CEO Kevin Plank who has done an incredible job. The company just celebrated its 10 year anniversary and it has come a long way. The big question for investors is where is this company going? Ten years ago, they started out by making compression t-shirts but they have transformed over the last couple of years and gotten involved in technology.
The company has been investing heavily in its future the last couple years. In 2015, they made a big push to make Under Armour a global brand. The company opened about 100 stores internationally. They particularly targeted China by opening about 75 stores. Prior to 2015, they only had 9 stores open in China. Investing in China right now is tough. We know that their economy has slowed down but no one knows how much economic growth there is today, if any. In addition, future economic growth is hard to predict. On one hand, you could say that this is a good time to be investing because in three to five years their economy might be steadily growing again. On the other hand, things could continue to slow which could impact Under Armour’s growth expectations.
Another growth driver for the company is in footwear. Many analysts have their eye on this segment. The segment has shown solid growth over the last five quarters. Please see the chart below indicating the footwear comps.
Footwear now accounts for 20% of the company’s revenues. CEO Kevin Plank has said that he wants to be the number one seller of athletic footwear which takes direct aim at Nike (NYSE:NKE). Under Armour has signed endorsement contracts with some amazing athletes that have tremendously helped drive growth in footwear. Stephen Curry in basketball, Jordan Spieth in golf, along with Tom Brady and Cam Newton in Football. Basketball shoes have demonstrated the strongest growth driven by the Curry 2’s that were launched in China last September. Obviously the company can not continue to grow this segment at an average of 50% per year. In fact, during the Q3 earnings call, the company mentioned that they had to discount some shoes to clear them out going into Q4. This had an impact on gross margins and the company’s average selling price (ASP) per unit metric. ASP’s have increased over the last few years due to the price point of their shoes. It will be important for the company to have strong footwear sales in Q4 or investors may worry.
In 2015, the company took a more definitive stance in fitness technology. They acquired Endomondo and MyFitnessPal in 2015 to go along with the UA Record and MapMyFitness apps it already owned. In Q3 Kevin Plank stated that with all four apps, they have had 150 million downloads. The hard part for investors is we have no idea how to think about this part of the business. It currently doesn’t make much money and there is no way to know if it ever will. Last week at CES, the company announced that the apps have a combined 60 million monthly active users (MAU), over 1.5 billion workouts logged, and over 6.5 billion foods logged. Currently, the company is collecting tons of data from the users and trying to figure out how to best leverage it. Under Armour’s fitness community of 150 million users is larger than Fitbit’s (NYSE:FIT). This part of the business is nearly impossible to value. This is uncharted territory and its hard to know if these apps will drive consumers to buy more apparel and footwear. That seems like what the company is hoping will happen.
Under Armour’s valuation has always been rich. However, investors have been willing to buy the stock because of the growth. Some people justify buying the expensive stock because “The valuation has always been high.” This is a horrible justification. The company has shown incredible and consistent growth by posting 20%+ growth for 22 straight quarters but this won’t happen forever. When I looked into this company, it was clear that they understand how Wall Street works. They always give conservative guidance in Q4 for the upcoming year and then they raise guidance each quarter. It happens year in and year out and Kevin Plank comes up with great excuses for the conservative guidance issued in Q4. In my opinion, companies that use this strategy have a higher probability of the stock selling off after reporting Q4 than in the other quarters. This could create an opportunity.
When I look at the valuation, it is definitely tricky. It is tough to value it on a relative basis because it is difficult to find a company with similar risk, growth, and cash flows. An intrinsic valuation is difficult too due to the explosive growth and uncertainties around China, footwear, and the technology aspect. When I looked at the financials, the SG&A expense financial statement line item is something to note. When I looked at the ratio of SG&A expense to revenues it reminds me of Amazon (NASDAQ:AMZN). The reason it reminds me of Amazon is due to the fact that there is a large disconnect between revenue growth and earnings growth. In Q4 2014, the company gave guidance for operating income of $405 million in 2015. Fast forward to Q3 2015, the company has increased revenue projections by $150 million but operating income projections are still at $405 million. Where is the $150 million going? SG&A expense. The reason I bring this up is because I do not consider all of SG&A expense to be a “true expense.” The company is investing in the future of the company and the brand. They are using this money to invest in fitness apps and opening new stores. In theory, they are creating assets and a better brand with this SG&A expense. For Under Armour, I assumed that 50% of SG&A would be a “true expense” and I amortize the other 50% over twenty years. I deem this to be pretty conservative and it helps me get a better understanding of what the company would be like in a stable growth environment. Using this assumption I reached an intrinsic valuation of $74 representing about 10% upside. Please see the chart below that reflects how my assumption impacts valuation metrics.
Using this assumption, the P/E ratios for Under Armour are still relatively expensive. In my opinion, Under Armour is a terrific company that has a bright future but I am not willing to pay for excessive valuations.
I think that Under Armour is a great company. The company is young and continues to grow. There are just a few issues. Investors have high expectations for the company and the return on the investments of the company is hard to predict. The company reports Q4 earnings on 1/28/15 and will give 2016 guidance. I would like them to give overly conservative guidance once again and have the stock fall. This is a company that I would like to own at a fair price. I plan on staying patient and hopefully the valuation will continue to come down.
As always, thanks for reading!