We see Under Armour (UA) apparel everywhere. It seems like everyone has something with an Under Armour logo on it. But how do investors know whether Under Armour is an attractive investment or not? Well, we perform a rigorous discounted cash-flow methodology that dives into the true intrinsic worth of companies. Let's see if we can answer this question.
But first a little background, we think a comprehensive analysis of a firm's discounted cash-flow valuation and relative valuation versus industry peers is the best way to identify the most attractive stocks at the best time to buy. This process culminates in what we call our Valuentum Buying Index, which ranks stocks on a scale from 1 to 10, with 10 being the best.
Essentially, we're looking for firms that overlap investment methodologies, thereby revealing the greatest interest by investors (we like firms that fall in the center of the diagram below). We think most of the major drivers behind a stock's capital appreciation (meaning it going up) have to do with its valuation and technical/momentum considerations. Remember, we're not just looking at a few valuation metrics, we're building a three-stage discounted cash-flow model at Valuentum.
If a company is undervalued both on a DCF and on a relative valuation basis and is showing improvement in technical and momentum indicators, it scores high on our scale. Under Armour posts a VBI score of 6 on our scale, reflecting our 'fairly valued' DCF assessment of the firm, its neutral relative valuation versus peers, and bullish technicals. We compare Under Armour to peers Coach (COH), Estee Lauder (EL), and Nike (NKE). Though these aren't perfect comparisons, we think Under Armour falls in this group based on the quality of its brand. In the spirit of transparency, we show how our strategy has stacked up relative to peers:
Our Report on Under Armour
• Under Armour earns a ValueCreation™ rating of EXCELLENT, the highest possible mark on our scale. The firm has been generating economic value for shareholders for the past few years, a track record we view very positively. Return on invested capital (excluding goodwill) has averaged 31.4% during the past three years.
• Under Armour makes branded performance apparel, footwear and accessories for men, women and youth. The brand's moisture-wicking fabrications are engineered in many designs and styles for wear in nearly every climate.
• Under Armour's cash flow generation and financial leverage aren't much to speak of. The firm's free cash flow margin has averaged about 1.9% during the past three years, lower than the mid-single-digit range we'd expect for cash cows. However, the firm's cash flow should be sufficient to handle its low financial leverage.
• Although we think there may be a better time to dabble in the firm's shares based on our DCF process, the firm's stock has outperformed the market benchmark during the past quarter, indicating increased investor interest in the company.
• The firm experienced a revenue CAGR of about 28.9% during the past 3 years. We expect its revenue growth to be better than its peer median during the next five years.
Economic Profit Analysis
The best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital (ROIC) with its weighted average cost of capital (WACC). The gap or difference between ROIC and WACC is called the firm's economic profit spread. Under Armour's 3-year historical return on invested capital (without goodwill) is 31.4%, which is above the estimate of its cost of capital of 10.8%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT. In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Under Armour's free cash flow margin has averaged about 1.9% during the past 3 years. As such, we think the firm's cash flow generation is relatively MEDIUM. The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. For more information on the differences between these two measures, please visit our website at Valuentum.com. At Under Armour, cash flow from operations increased about 299% from levels registered two years ago, while capital expenditures expanded about 68% over the same time period.
Our discounted cash flow model indicates that Under Armour's shares are worth between $47-$87 each. Why such the big range? Click here. The margin of safety around our fair value estimate is driven by the firm's MEDIUM ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $67 per share represents a price-to-earnings (P/E) ratio of about 55.3 times last year's earnings and an implied EV/EBITDA multiple of about 27 times last year's EBITDA. Our model reflects a compound annual revenue growth rate of 18.2% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 28.9%. Our model reflects a 5-year projected average operating margin of 13.7%, which is above Under Armour's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 10.5% for the next 15 years and 3% in perpetuity. For Under Armour, we use a 10.8% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $67 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values. Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for Under Armour. We think the firm is attractive below $47 per share (the green line), but quite expensive above $87 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate Under Armour's fair value at this point in time to be about $67 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the firm's current share price with the path of Under Armour's expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $91 per share in Year 3 represents our existing fair value per share of $67 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Pro Forma Financial Statements