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Today, we are updating coverage on Under Armour (NYSE:UA). Due to recent upside in shares and a lack of our overall model growing (sales increasing at a faster rate than we had laid out in our last article) at the same rate, we are downgrading the name to Hold from Buy. We had liked the name as of our last update in late 2013, but the company's valuation is now not as appealing. Our main argument during that time, and today, is that the company has strong appeal based on their women's apparel business. The company's push is quite appealing, but given a 35%+ increase since our last article, we are seeing a lot of this priced into shares.

We have upped our price target to $119 from $95 for 2014, but this is because the calendar shifted from 2013 - 2017 to 2014 - 2018 for our analysis since the last time we covered the company. We would like to note that we called the stock a Buy in October when shares were trading around the $80 mark and the stock has returned over 30% since. We like now holding for those that are long, and for those that are not involved, waiting for a pullback, before adding.

Current Oxen Thesis

Main Catalyst

After analyzing the UA stock, we have given it a Hold recommendation. The company's main catalyst is its planned expansion into women's apparel. We like this catalyst due to the high gross potential of the women's apparel market, its shop-in-shops approach to enhance its market presence, its ability to charge a higher price to its customers, and the incredible shopping experience that it delivers to consumers.

By looking at the overall apparel market in the U.S., it is evident that there is opportunity for growth in the women's segment. The U.S. apparel market reached over $180 billion in total revenue in 2013, with 60% belonging to women's, followed by men's and children's. The women's apparel market has higher growth potential than men and children's. It is expected that the total global luxury apparel sales will reach to $307.5 billion by 2015, suggesting that there is opportunity for growth not just in the U.S., but globally. Even though the industry is highly concentrated today with the top 20 companies occupying 30% of the market share, the industry is expected to dilute, allowing smaller players to gain market share.

In addition, UA's shop-in-shops approach, which is a way that UA can take space in other retail stores to sell its brand, provides a great platform to launch its women's apparel growth plan. We believe that the shop-in-shop approach would greatly help UA tap into the women's apparel market by allowing lower costs and generating more sales because UA can share its costs and marketing with its partner retailers. For example, UA has investments in shop-in-shop concepts at Dick's (NYSE:DKS) and The Sports Authority. By using dedicated floor space exclusively for its products, including flooring, lighting, walls, displays and images, it can attract more consumers to its brand over other brands in-store.

Further, UA has the ability to charge a price premium to its customers due to the high quality of its products. UA is expected to charge a 5% higher average selling price in the upcoming quarter. This is due to an increase in sales of its higher priced products such as Fleece, its women's UA Studio line, and UA Spine footwear. This means that UA is gaining more brand recognition in the current market, and the increase in brand recognition will be a valuable resource that UA can leverage to gain access into the women's market. Further, the higher price point for women products will help to give the company better gross margins.

Additionally, support for this catalyst is that UA will deliver more than just a product, but it wants to bring customers an incredible shopping experience. An example of this ideas is the UA's Women's Studio. UA has allied with several partners for its studio presence to demonstrate that it offers much more than compression shorts and sports bras. For example, in the Lux Shops at Dick's, UA occupied prime floor space exclusively for its products with lights, walls, displays and images. Consumers can not only buy UA's products there, but also experience a comfortable and relaxing shopping experience. The incredible shopping experience that customers can gain is also a reason why UA can increase its brand recognition in the marketplace. Creating a culture of educating customers and bringing a comfortable and relaxing shopping environment to customers would help UA be viewed not just as a apparel producer but a place for relaxing and learning.

Last but not least, UA has gotten a head of its division that is exceptional. UA's plans to open its first store in southern New York City in the early part of 2014 is led by Leanne Fremar. Leanne Fremar, as the senior vice president and executive creative director to oversee women's marketing, products and design, can help to build UA women's apparel business. Leanne Fremar came to UA from Theory and she has spent over 10 years working for high-end men and women's retailers, including Gucci Group (OTC:GUCG) and Polo Ralph Lauren (NYSE:RL), as the creative director. Along with other brand experts, UA is taking actions to bring women more than just athletic apparel, but something beyond their expectations. By leveraging the deep knowledge and professional experience that Leanne Fremar and other brand experts UA have, we believe that UA will be better able to understand its female consumers and provide the products, services and shopping experiences that best fit their needs.

However, while there are plenty of reasons supporting this positive outlook, there are still some risks and challenges that need to be watched. The competition in the women's apparel industry is still very intense which requires the competitors to find new ways to approach its customers. For example, Lululemon Athletica (NASDAQ:LULU) has strong brand recognition in the industry as a women's yoga apparel retailer. There is still the question of how UA would compete with a company like LULU that has already existed in the market for so long. What's more, mobile commerce is the key driver going forward into 2015. On this side, we still haven't seen any specific plans from UA for its mobile business in the women's market. It would make sense to enter the market with a mobile-first approach to level the playing field, but we are concerned about the lack of emphasis here.

In conclusion, the UA's sales from its women's market are expected to approach to $500 million by the end of 2013. By 2016, UA plans to reach $1 billion sales in the women's apparel market, which will be double of the current sales. UA has a lot of growth potential in the women's apparel market due to the high gross potential of the women's apparel market, its shop-in-shops approach to enhance its market presence, its ability to charge a higher price to its customers, and the incredible shopping experience that it delivers to consumers. However, due to the intensive competition in the industry, and the transformation of the industry to require its retailers to find new ways to approach its customers, especially due to the rise of mobile commerce, we need to keep a close eye to see how UA plans to seize the opportunities in the market.

Pricing/Valuation

Based on the Q4 Earning Call Transcript, Under Armour is expected to grow sales 22% in fiscal 2014 and their ambition extends well beyond $4 billion in revenue. Thus, there is an 18.68% of CAGR in these years. The gross margin and operating margin in recent years are both very stable with a little fluctuation. So we can use the average rate of last 5 years. The same idea is used in the calculation of income taxes and increase in working capital. As for the capital expenditures, the company expects it to goes between $140 million and $150 million in 2014. Finally, a 7.50% WACC is applied to our model.

When we use these numbers, we come to a price target of $119 using The Oxen Group's cash flow analysis model. At current prices, this price target is not providing a ton of upside.

2014E

2015E

2016E

2017E

2018E

Operating Income

310

368

437

518

615

Income Taxes

121

144

171

203

240

Depreciation

56

62

68

74

80

CapEx

-140

-145

-145

-145

-145

Changes in W/C

70

70

70

70

70

Total

35

71

119

175

240

Risk/Variance

Even though UA has a good potential to grow in the next several years, there are still risks involved. One of the risks is a possible decline in the athletic apparel trend or fad at gyms. As an athletic apparels supplier in the marketplace, UA would like to see its existing market to keep growing over the long term from an increase in the number of people working out. Another risk is the raw material cost from its suppliers. As mentioned before, even though UA has very limited bargaining power from its suppliers, the increased raw material cost of its suppliers would still put some pressure on UA's operating margin.

Conclusion

In conclusion, we believe the company has a great opportunity to grow and seize market share, but some uncertainties still exist. UA has prepared a lot for entering into the women's apparel market, which might lead to a tremendous growth in the next several years. Yet, the mobile business will be the key driver for the women's apparel market to 2015 and we still haven't seen any mobile business plan that UA is considering in the market.

Source: Under Armour: Can They Make A Dent In Women's Apparel?