Under Armour (NYSE: UA) has been the subject of heated back-and-forths of late, as detractors of the company argue that its current P/E ratio of 39.16 is far too high and as a result, the company is now the most heavily shorted stock on the S&P 500.
Through this article, I will argue that the short-selling is justified and that Under Armour is poised for significant corrections.
Under Armour's high valuation is based fundamentally on one thing: growth. The company has expanded very quickly and has enjoyed nonstop years of 25%+ revenue growth, which has allowed it to reach an absurdly high P/E ratio. Its name has been tied to some of the most well-known names in both collegiate and professional sports, signing stars such as Stephen Curry, Michael Phelps, Jordan Spieth, and the company signed UCLA to the largest college apparel deal in history.
It has wowed its investors with massive international growth by %, announcing that overseas revenues spiked by 68% in the previous quarter. It's continued to aggressively expand into China, sending Steph Curry on several overseas trips to promote the brand and his iconic blue-and-gold basketball shoe.
However, I believe that Under Armour is poised for significant corrections despite the 15% drop in share price over the past few weeks. My concerns about Under Armour revolve around its poor operating margin, slowing growth, resurgence of Adidas (OTCQX:ADDYY), and the headwinds it will face as it seeks to even the playing field with its two big brothers, Nike (NYSE:NKE) and Adidas.
Profitability and Operating Margin
Under Armour has unsurprisingly needed to pay to maintain its explosive growth rates, and according to its last quarterly report, its operating margin is currently at 1.9%.
Well below Adidas and Nike's operating margins of 7.5% and 13.9%, respectively, Under Armour has consistently struggled to produce solid profits as a result of the enormous spending it has had to do to compete with the massive marketing power of Nike. As it attempts to expand aggressively in China and grow in the United States, this number is poised to decrease.
It is at a disadvantage as its revenue is much smaller than those of Nike and Adidas, yet it still has to shell out the same, if not a larger sum of money for its endorsement and sponsorship deals with big-name athletes and institutions. This is unlikely to improve in the future as the company attempts to diversify and expand into different reaches of the sportswear market.
This is the primary reason why I am bearish on Under Armour. UA, which made headlines last year for overtaking Adidas as the number two sportswear company in the United States, was praised as the heir apparent to Nike. At this time, Adidas was seen as an out-of-touch brand that was losing ground quickly to Nike and UA.
However, this trend completely reversed and not only has UA lost its crown as the number two sportswear company, it is not even the fastest growing sportswear company in the US. These titles have both been won by Adidas, which has experienced a massive resurgence in the United States on the back of their casual lifestyle sneakers and popular running sneakers.
For a smaller company like UA whose high valuation is justified by growth, these numbers are troubling and indicative of the fact that UA is seen primarily as a maker of performance goods.
International growth has been highlighted as a bright spot for the company, with overseas revenues skyrocketing 68% to roughly $150 million in the last quarter. However, the impressive percentage gains are mainly a consequence of the fact that UA is just beginning internationally and I expect international growth to slow as UA will face difficulties taking market share from Nike and Adidas.
Adidas in particular has reported 30% revenue gains in China alone to $685 million. Nike which currently maintains the largest presence in China of the three companies in this article, is still rapidly expanding in China with double-digit sales growth reported for the last quarter on the back of its beloved NBA atheletes such as Kobe Bryant and Lebron James.
UA's international growth prospects, which are the primary driver of its high valuation, is sure to slow as it meets headwinds from Nike and Adidas, which are both well-established and quickly growing in international markets.
UA's overall revenue growth has decreased steadily, an indicator of the fact that the brand is slowly beginning to mature and is no longer the high-growth superstar it once was. Its 50x forward P/E ratio was one of the reasons for a "neutral" rating by Nomura, whose analysts pointed out that the company is valued at 2018 levels and must continue to perform spectacularly without mishaps to maintain its share price.
Its Sportswear collection, UA's first foray into the high-fashion market, is unlikely to make a big impact as it is forced to compete with much more established and respected names in the fashion industry such as Ralph Lauren (NYSE:RL).
I have trouble seeing how upper-class millennials and professionals will happily spend $1500 on trench coats or $179 leggings, with the plethora of other options from big-name designer firms. The company may find it is spreading itself too thin as it attempts to shed its image as a maker of solely performance-based gymwear and become a beneficiary of the athleisure trend that Adidas in particular has excelled in.
While UA has performed well on a long-term basis and has enjoyed headlines and narratives that highlight the company as Nike's main competition, Adidas's rapid resurgence and Nike's continued presence are sure to hinder the company's growth and decrease its profitability as it is forced to shell out big money to attract athletes and advertise on the same level as its two bigger brothers.
I would advise Under Armour investors to consider looking for other investment opportunities in the sportswear industry. Adidas, for example, currently trades with a P/E ratio of 32, a huge distance from UA's P/E ratio of 39.16 despite higher profitability and relatively similar growth rates.
I would also add that UA is a solid short candidate as I believe its next quarterly report on 10/22 will be unimpressive and will reflect the headwinds that I mentioned in this article.
Disclosure: I am/we are long ADDYY.
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.