Under Armour - Growth At A Price

Oct.29.13 | About: Under Armour, (UA)

Under Armour (NYSE:UA) has made a name for itself in the performance wear market with innovative, specialized, high-performance athletic apparel, footwear and accessories. Its apparel sales in North America and overseas comprises over 75% of its revenue with climate clothing lines such as ColdGear, HeatGear and AllSeasonGear. Since 2006 it has also been marketing its performance footwear line that is about 13% of sales, with accessories being about 9% and the remaining 2% attributed to licensing arrangements with licensees that use the company's trademarks. The company sells its products mainly through the wholesale channel, that is, placement of products with retail partners like major sporting goods stores, direct to consumers sales (online channel, factory stores, and a few full line stores), and also its specialized shop that develops products quickly for special orders from high profile clients.

The company has been posting solid revenue growth numbers quarter after quarter across product lines. Its Q3 2013 earnings released on October 24, 2013 showcased a 26% revenue growth with the largest product segment, apparel, growing by over 20% for the sixteenth consecutive quarter. But despite beating expectations in Q3, the company's shares took a tumble. Between 2008 and 2012, the company achieved topline growth of 153%. There was nearly a 33% increase in direct to consumer sales in Q3 making it a fourth of net revenue. Growing direct to consumer sales is a good sign for the company in terms of higher average sale price and also bodes well for online sales during the upcoming holiday season. There were 22 new factory stores opened between 2011 and 2012. In the remainder of 2013, it plans to open 4 new factory stores, one new full price store and expand 9 existing facilities. While the growth story so far has been compelling, the company's shares trade at over 60 times earnings. So the big question to justify an earnings multiple like that is the sustainability of the company's robust growth in the future.

International Markets: Over 90% of the company's revenue is generated in North America, leaving substantial room for expansion internationally. Taking advantage of growing income levels and favorable age demographics internationally can be a crucial factor in its long-term success. Management has shown its commitment to grow the company into a global entity by making major investments, notably in Latin America, and also in China, Japan and Europe. The challenge is to build brand recognition in foreign countries where larger names like Nike and Adidas are a major presence. To that end the company has launched an "experience" store in Shanghai to attract customers with a novel shopping environment. It has formed partnerships with entities like Colo Colo, one of the largest soccer clubs in Chile, and the football club Tottenham Hotspur in England as part of its marketing plan. In Q3 2013, net revenue from international sales was up 38% over prior year fueled by strong growth in Europe and Asia. This is a promising sign that the investments the company is making around the globe is beginning to bear returns. However, it faces stiff competition from big names such as Nike in international markets.

Women and Youth: Under Armour management has indicated in the Q3 earnings call that the Women's product category has outpaced overall company growth and is expected to be about a $1 billion business by 2016. So far the company's initiatives have included Brand Holidays and Women's Studio to improve marketing of its products to female clients. In this regard, management conceded that it is important to understand where women shop and to expand product selections beyond the basics at those distribution points. Currently a gap exists wherein the company has over 1000 department stores carrying its products, but only a limited number of product lines. I think that an opportunity exists for the company in women's apparel, footwear and accessories that can be realized with better product development, placement and marketing.

While many major retailers have been struggling lately with the juniors/youth apparel and accessories segments, Under Armour has been successful with this group of customers. The sales in its youth segment have not only been strong on the core apparel side, but also in footwear. The introduction of the Alter Ego line in partnership with Marvel and D.C. Comics in 2013 was successful and a good example that the company has its finger on the pulse of this market. I think the challenge in this market is that the company has to continuously compete with not only other sellers of performance gear but also completely different product lines for the attention of their young customers. Will teenagers be getting performance wear and running shoes, or a smartphone or video games for the holidays this year?

Innovation and Intellectual Property: The lifeline of a company like Under Armour is innovation and it has been delivering in terms of exciting products like fabric that repels heat from the sun, fabric that repels water without restricting airflow, cotton that dries like synthetic fiber, scent-control apparel and many more. In the performance wear business, smart innovation can mean customer growth as well as pricing power. In Q3, the company's average price grew 5% in the apparel segment. I read an article where Jim Cramer mentioned the idea of Under Armour releasing cool, "wearable tech" in the future. I think a sophisticated and practical gadget that can track crucial data for athletes could open new doors for the company and sounds like an idea that would be right up its alley.

One concern is that the technology and materials used by the company are not unique to it and it does not own any process or fabric patents. This is a risk to the business as larger competitors like Nike can out-price and out-sell it in the absence of unique, patented technology. A mitigating factor is that the company has applied for some patents of unique products and designs in 2012 and expects to file more in the future. Alternatively, Under Armour owns several trademarks that in some ways can be more useful than patents. Trademarks can last indefinitely compared to patents which are time limited, and can prove more useful for brand building and marketing.

Valuation and Volatility: The trailing P/E multiple puts Under Armour at an expensive valuation of over 64 times earnings. The price-to-sales ratio of 4.2 is more modest but still higher than some of its direct competitors. Judging by its continued solid performance and intriguing growth story, it may be able to continue the strong double digit growth into the future and justify this price. My concern is that despite solid performance in the third quarter on both revenue and EPS fronts, the stock plummeted after an earnings beat. To me, this reinforces the risks associated with investing in a stock that generates a lot of interest and gets a lot of coverage, even if it represents a strong underlying business. Expectations play a major role in stock performance and it seems like Under Armour has to manage some very high ones. It faces some formidable competition and needs to consistently stay ahead of the game by coming out with sleeker, cooler products that can command a higher price. Overall I think that while the company offers growth, it may not offer stability for more conservative investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am a self-taught individual investor and this article expresses my views based on my own research. I am not being influenced or paid by any organization to write this article.