Under Armour: Still Overvalued Despite The Sell-Off

| About: Under Armour, (UA)

Summary

Under Armour has shown industry leadership over the past five years.

However, investment decisions should be based on the future expectation, not the past data. The main concerns are: the Chinese expansion, extremely high multiples, and revenue and inventory instability.

The DCF, zero-growth, and comparative analyses show the stock is terribly overvalued even after the bad year-start.

The last twelve months showed that Under Armour (NYSE:UA) is an ideal candidate for further research. The company's expansion in China with high growth results (the segment's revenue has increased by more than 32%, while net income has increased by 28%) are the main factors making the company look attractive in the eyes of investors. The recent market crash presents an opportunity of a cheap entry into the stock. The acquisitions of Endomondo and MFP fitness-centers make it seem like the company has been successfully implementing its diversification strategy.

Despite the positive introduction, I have some serious concerns about the company:

The Chinese expansion may not be as successful as initially expected in the long-run, according to the current situation with the Chinese economy. I am not an analyst or an investor who follows the "great global market crash" theory but I see it clear that the company's Chinese market growth expectations are too high.

Average operating margins coincide with the highest price multiples. High revenue growth will come to a halt at some point in the future, and the main factor making the company look competitive among other industry players will be its cost efficiency. According to Diagram 1, the company is currently slightly less efficient the Apparel industry, on average, while the P/S, P/E, and P/BV ratios are going through the roof.

Accounts receivable and inventory levels are increasing making the cash conversion cycle grow to whopping ~200 days. Diagram 2 shows that, during the last nine months, the cycle has increased by more than 45%. Because of modest revenue, the company will have to sell its inventory at a discount in the future. It will surely affect both the operating margins and the quality of the operating cash flows.

Diagram 3 shows operating cash flow dynamics for the last 12 months. On the one hand, the significant decline to the negative levels is explained by preparations for the Black Friday. On the other hand, this year, it is not likely to be higher than the previous year's results.

Diagram 1

Source: data - Morningstar.com, infographics by author

Diagram 2

Click to enlarge

Source: data - Morningstar.com, infographics by author

Diagram 3

Source: data - Morningstar.com, infographics by author

These facts make me concerned about the company's future perspectives. Moreover, I am still concerned about the fairness of the current valuation (I have a stomachache when see P/E levels of 70+ for an apparel company). Hence, I am going to use my traditional set of analyses (DCF, zero-growth, and comparative) to establish the company's fair price.

DCF analysis

My DCF model is presented in Diagram 4. I have made several assumptions, which can be easily seen in the "Assumptions" tab of my Excel file. Pay a special attention - they are quite optimistic. The forecasted 7-year revenue CAGR is set to be at a level of 23%. The forecasted 7-year FCFF CAGR is more than 55%, while the historical five-year CAGR has been negative 25%.

My model shows that, after subtracting the market value of debt, minority interest and adding back cash and investments, the market value of equity is around $9B in the Base scenario. Consequently, the fair value per share is $40.35 per share. It is more than 40% lower than the current price ($68.61 per share).

Diagram 4.

Click to enlarge

Source: data - Morningstar.com, DCF model by author

Sensitivity Analysis

The sensitivity analysis is presented in Diagram 5. According to the Base scenario and the assumptions for the EV/EBITDA multiple and WACC, the fair price range is estimated to be between $35.6-$46 per share. This price range represents a 36%-51% downside risk.

Diagram 5.

Click to enlarge

Source: data - Morningstar.com, model by author

Zero-Growth Analysis

The Zero-growth analysis has been described in one of my articles. You can read more about it here.

According to this analysis, the current stock price shows no margin of safety. The valuation gives a fair market value of equity of $4.8B, which transforms into a fair price of $21.4 per share. This price level is 70% lower than the current price level. If we only used net income in the calculations, the result would be a fair value per share of only $15. It is ~80% lower than the current price. So, we can definitely say that the stock price has no margin of safety right now.

Comparative Analysis

My comparative analysis is based on three key ratios: P/E, P/S, and P/BV (see Diagram 6). All ratios show that the stock price is extremely overvalued. The current EV/EBITDA multiple is at a level of 35.7x (very high!), while the industry's average is 10.84x (according to the refreshed Damodaran data tables). Therefore, the company is surely overvalued.

Diagram 6.

Click to enlarge

Source: data - Morningstar.com, infographics by author

Opinion

Under Armour showed leader's ambitions in the previous years. No doubt, the results have been very impressive. However, paying a high price for a company with cash conversion cycle and revenue concerns seems to be a risky idea. My DCF analysis with some ultra-positive assumptions shows that the stock is too expensive. The comparative and the zero-growth analyses confirm the DCF's results.

Hence, I the only recommendation I can give the stock is a SELL. Target price range is set to be $36-$46 per share, which translates into a 35%-50% downside opportunity for the stock.

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.