Under Armour, Inc. (NYSE: UA) is one of the most compelling growth stories in today's stock market. Investors who have owned this stock since November 2005 are probably very happy, because the total return on their investments is 988% based on Friday's close. Therefore, it comes not as a surprise that many investors are very positive about this company and its growth prospects going forward.
In today's bull market, investors sometimes focus too much on revenue growth and, as a result, overlook the actual earnings capacity of growth stocks. I believe this is the case for Under Armour as well. In this article, I will discuss Under Armour's growth potential in respect to the company's spending. Further, I will compare Under Armour's valuation with its peer firm: Nike, Inc. (NYSE: NKE).
Growth of revenue
Due to very strong revenue growth over the past years, Under Armour is one of the major sports apparel companies measured by market capitalization. Still, the company is relatively small compared to market leader Nike. Nike's market capitalization is 4.5 times that of Under Armour (see table below).
|Under Armour||$14.68 billion|
Under Armour is likely to continue its strong revenue growth in the upcoming years. In this article, Seeking Alpha contributor Karoline Porcello identifies five catalysts that will support Under Armour's revenue growth: footwear sales, women's apparel, connected fitness technology, direct-to-consumers sales and international expansion.
In my opinion, the expansion of Under Armour's international business will be a big contributor for the company's strong revenue growth in the future. International sales represented only 8.5% of the company's total revenue in the second quarter. However, second quarter international sales rose from $25.6 million in 2013 to $51.6 million in 2014 (an increase of 101% y-o-y).
Due to its high revenue growth rate, Under Armour trades at a relatively high price/sales multiple (hereafter: P/S ratio) compared to Nike. Under Armour's P/S ratio is 6.30 and Nike's P/S ratio is 2.65, based on their total revenue in fiscal year 2013. However, if Under Armour could be able to match Nike's forward P/S ratio in 2018 (see graph below).
For my calculation I made the following assumptions:
- Under Armour will grow revenue by 27.5% per year (average growth rate over the past ten quarters).
- Nike will grow revenue by 8.6% per year (average growth rate over the past ten quarters).
So, based on the information above, it is not unlikely that Under Armour will eventually match Nike's P/S ratio. I would like to point out that my calculation is based on assumptions and that the actual revenue growth rates of Under Armour and Nike will differ from these assumptions.
Growth of expenses
Most investors focus on revenue growth and Under Armour is without a doubt outpacing Nike's revenue growth. However, expenses are another important factor, because it affects cash flow and earnings per share. Therefore, investors should take gross margin and increasing selling, general and administrative expenses (hereafter: SG&A) into account as well.
Under Armour is a relatively new brand and the company invests a lot of many to support brand awareness and customer loyalty. Nike on the other hand is an established brand. According to Forbes, Nike ranks number 24 as the world's most powerful brand with a brand value of $18.2 billion. Under Armour does not rank among the top 100 most powerful brands.
As a relatively new brand, it makes sense that Under Armour's selling and marketing expenses are higher than Nike's selling and marketing expenses as a percentage of total revenue. Indeed, Under Armour's SG&A expense ratio exceeds Nike's SG&A. On the other hand, Under Armour's costs of goods sold (hereafter: COGS) is lower than Nike's COGS (see graph below).
Growth of EBIT
Based on the information above, I calculated Under Armour's and Nike's earnings before interest and taxes (hereafter: EBIT) to compare the EBIT in 2018 to their current market capitalization. This will give an insight in the companies' earnings potential in respect to their current valuation.
I based my calculation on the following assumptions:
- Under Armour will grow revenue by 27.5% per year.
- Under Armour's COGS 51.0% of total revenue.
- Under Armour's SG&A 39.0% of total revenue.
- Nike will grow revenue by 8.6% per year.
- Nike's COGS 55.8% of total revenue.
- Nike's SG&A 31.0% of total revenue.
The result of my calculation is shown in the table above. Following my assumptions, Under Armour's EBIT will increase from $288 million in 2014 to $762 million in 2018. This equals a Price/EBIT ratio of 19.26. Nike will increase its EBIT from $3.67 billion in 2014 to $5.05 billion in 2018. This equals a Price/EBIT ratio of 13.27. This implies that Under Armour is overvalued compared to Nike.
Again, I would like to point out that my calculation is based on assumptions and that the actual results of both Under Armour and Nike will differ from the outcome of my calculation.
First of all, I believe Under Armour is a great company. I fully support this positive article regarding Under Armour's ability to grow revenue at a fast pace in the upcoming years. The company's international sales will be a major support for its future revenue growth. If I was to judge based on revenue growth alone, Under Armour would have come out on top of Nike.
Despite Under Armour's revenue growth, I do not believe it is a good long-term investment. I find that Under Armour's expense level is relatively high compared to Nike. This is not illogic, because Under Armour is a new brand and, therefore, needs to invest more to create brand awareness and customer loyalty. However, it has a negative impact on Under Armour's ability to earn money for its shareholders.
Based on my calculation and assumptions, Nike's Price/EBIT ratio for 2018 is 31% lower than Under Armour's Price/EBIT ratio. This implies that Under Armour is overvalued compared to Nike. My findings are in line with two other articles (this and this article), regarding Under Armour's expensive valuation. Therefore, I do not consider Under Armour as a good long-term investment and I will wait for the stock to drop significantly.
Disclosure: The author is long NKE. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.