Athletic apparel company Under Armour (UA) has seen its shares climb 41% since the beginning of the year. Shares have significantly outperformed its top competitor, Nike (NKE) (up 5%) and yoga apparel maker Lululemon (LULU) (up 32%). We also consider Under Armour to be highly overvalued; we think the shares are worth as much as $78 on a DCF valuation, though the stock currently trades at around $101.
The firm has yet to exhibit the robust cash-flow generation of its peers, and we suspect investors are overly optimistic about its ability to do so in the future. But while we think the company is highly overvalued, we do not consider the company a very attractive short or put option candidate for the portfolio in our Best Ideas Newsletter at this time on the basis of a technical assessment. However, this view may change in coming periods.
Under Armour's Relative Multiple Valuation Isn't Out of Line
Based on our 2012 earnings forecast, Under Armour's price-to-earnings ratio is not completely out-of-line versus peers. Shares are currently priced around 40 times our higher-than-consensus earnings estimate, while Lululemon is priced at around 37 times and Nike is at 21 times our 2012 forecast. Though slightly higher, Under Armour's price-to-earnings ratio isn't too lofty based on a peer assessment. So, while its DCF valuation suggests an overvalued stock, we don't think Under Armour is that unattractive based on a relative valuation assessment.
CEO Kevin Plank Still Owns Over 20% of the Company
CEO and founder Kevin Plank still owns around 20% of the company. Though some of his holdings get sold automatically, we don't see him wanting to cash out by selling Under Armour any time soon. Plank loves his company and is its number one supporter. Plank is only 39 years old, has plenty of money and, as far as we can tell, has no interest in leaving the company he built from scratch. We view a highly motivated CEO as an asset to a growing firm like Under Armour.
Some Market Participants Think Nike Could Acquire Under Armour
Though we think it's one of the more ridiculous M&A rumors, plenty of market participants and pundits believe Nike may attempt to acquire the company. Nike recently announced its intention to divest Cole Haan and Umbro, which some think would free up cash for a big acquisition.
We think this idea is highly unlikely, but it could support the stock price if investors think there's a reasonable chance it could happen. Nike isn't one to acquire its competitors. If the firm does make an acquisition, it will either be at a great price (Cole Haan and Converse) or to enter a new market (Bauer and Umbro). Nike has never bought out a startup competitor like And1 or Dada, but has opted to simply create better products and win sales dollars. Though figures are unclear, we think Nike might sell as much of its own compression, "Under Armour" products, as Under Armour does. Nike is selling Umbro because it has stolen significant market share in soccer with its own products.
Competitor adidas (ADS) could make sense as an acquirer of Under Armour, but its acquisition of Reebok hasn't been particularly successful. The firm must also deal with prolonged weakness in its core European market, which could limit acquisition activity.
Under Armour's Business Model Isn't Broken
When we enter into put option positions in our Best Ideas Newsletter, we prefer overvalued companies that also have challenged business models, poor industry structural dynamics, and whose stock price has revealed bearish technical and momentum indicators. First Solar (FSLR), for instance, was among the high-cost producers in a declining industry, and the shares proceeded to converge to our fair value estimate. We also identified AMR (AMR) and Netflix (NFLX) as put-option candidates based on lousy fundamentals and challenged business models.
On the other hand, we were unsuccessful with a put-option position on shares of Chipotle (CMG), which we thought were overvalued. However, the company has continued to execute very well and introduce new concepts. Chipotle also has a very valuable brand. As a result, shares have not converged to our fair value estimate just yet. However, we may reestablish a put position in Chipotle in the future in the event we get confirmation of a turn in the firm's technicals.
We feel that Under Armour, at this time, carries a similar risk to Chipotle (as it relates to establishing a put option). Although the company's inventory build has exceeded revenue growth, the company is still growing earnings per share and top-line revenue at a high rate. The firm also has a well-recognized brand name, and it has started to get traction on dozens of new products including expanding women's offerings and shoes. In spite of mixed success with shoes and other new products, many market participants believe Under Armour will become the next Nike.
While we wait for Under Armour's technicals to deteriorate further (generating a lower Valuentum Buying Index score), we are avoiding entering into a put position in Under Armour at this time. We continue to look for overvalued companies with deteriorating industry economics, challenged business models, and poor technical and momentum indicators to establish put-option positions in the portfolio of our Best Ideas Newsletter.