Under Armour: The Rose Is Off The Bud

| About: Under Armour, (UA)

Summary

Under Armour collapsed to recent lows following a large downgrade from Morgan Stanley.

The momentum stock has a stretched valuation requiring zero hiccups in several growth initiatives to generate gains even after the dip.

The recommendation is to avoid Under Armour on a stretched valuation whether the negative data points are accurate or not.

under Monday's shocking downgrade of Under Armour (NYSE:UA) pushed the stock down 6.7% on a day the market traded flat. The very expensive momentum stock has several growth initiatives that retail data points suggest aren't working out.

The risk I've highlighted for a while was that the stock was priced for perfection. My last article suggested that it was impossible to justify the stock price with Under Armour trading at valuation that wasn't even supported by other hot retail stocks previously. One look at the five-year chart provides a big indication that gains were stretched. In fact, the below chart shows that the recent drop in the stock is only a blip of the gains.

Click to enlarge

The amazing part is that the stock is down over $35 and the value remains cloudy. Should investors use this dip to buy up this prominent retailer?

Growth Initiatives

The growth story with Under Armour centers around footwear, women's apparel and international expansion. The company was riding the sports leisure shift for domestic apparel growth, but new data suggests the growth initiatives are struggling.

According to Morgan Stanley, data from SportScan shows the company is already losing market share in women's apparel and reducing ASPs on footwear. In reaction, the analyst slashed the price target on the stock by roughly 40% to only $62. Under Armour now trades at $70.

The question is whether these data points really change the long-term growth story. Jordan Speith is still dominating golf and Steph Curry is on pace to win a second MVP of the NBA. The footwear sector and international expansion still appear as no-brainer growth drivers despite the noise from the SportScan data.

As a summary, the Q3 numbers were strongly tilted towards North American apparel. The company generated $1.2 billion of revenue with only $196 million from footwear. Footwear revenue grew 61%. International revenue grew 68% to $130 million, but Under Armour didn't break out revenue for the female demographic.

So how do we handle these new data points? First, women's apparel isn't meaningful to the financials at this point. Some market share loss isn't devastating to growth if the other initiatives remain intact.

The footwear issue is possibly explainable from a little research. The company provided one big caveat to the footwear ASP issue with this statement from the CFO on the last earnings call:

... we are now planning higher excess footwear liquidation sales as part of our normal inventory management process, which will negatively impact gross margin in the fourth quarter.

Common sense and comments from the management team during the Q3 earnings call suggest the footwear ASP is due to a change in managing inventory over a pricing power issue as suggested by Morgan Stanley.

Women's apparel will likely remain a struggle. Without any definite anecdotal evidence, Under Armour is a very masculine name that might preclude the segment from reaching full potential with female customers.

On the positive side, the recent announcement of the additional connected devices including the HealthBox might provide more upside. Under Armour lists over 150 million registered users for their fitness tracking community. The new fitness band places them in competition with Fitbit (NYSE:FIT) that despite the crushed stock still has a valuation of roughly $5 billion.

With a market value of only $15 billion, the connected device segment might have more potential and matter more to long-term growth than the struggling women's apparel.

Stretched Valuation Remains

The problem with the Under Armour story is that the valuation is still fully priced even after increasing the growth targets in October. The retailer still needs to hit it out of the park on several growth initiatives to justify the current valuation, even after the big decline.

In October, the company outlined long-term growth initiatives that included revenue growth of 25% and operating income of 23%. The problem with the stock is that even after the recent declines, the forward PE ratio is still off the charts for the growth rates.

Compared to other once hot retail stocks, Michael Kors (NYSE:KORS) and Lululemon Athletica (NASDAQ:LULU), Under Armour has further to fall before getting interested in the stock.

UA PE Ratio (Forward 1y) Chart

Takeaway

While maintaining some skepticism on the weak footwear numbers highlighted by Morgan Stanley, Under Armour is still too expensive to chase. The recommendation is to wait for the stock to finish the shakeout and let the market confirm or deny the negative data points before getting involved with the stock. The best part of the stock market is that investors don't have to participate in every idea.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.