Under Armour Still Overly Expensive

Apr. 7.08 | About: Under Armour, (UA)

If you happen to be long Under Armour (NYSE:UA) (35.25, $1.72 billion), let me say that this started out just being an article about how cheap Columbia Sportswear (NASDAQ:COLM) (46.02, $1.65 billion) appears to be. I am well aware of what a fantastic stock UA used to be and how exciting the brand is (was?). Long ago (in retail time), COLM was as well, rising from 8 in 1999 to a peak of 50 in 2001. Of course, the 8 was a drop of 50% from where it was trading after its 1998 IPO. UA is now also down 50% from where it was trading recently. Maybe better days are ahead, but, at least on paper, COLM sure looks like a better buy. Before I continue, allow me to confess that I don’t wear either of these brands and don’t really know much about fashion except that it tends to be fickle. My 12-year old son HAD to have Under Armour a couple of years ago and now won’t wear it under any circumstances, though my wife is getting good use out them!

While UA has always been expensive, I believe that it remains so despite a PE that has declined from 60 to 25 over the past eight months. The difference between today and eight months ago is that the trend is no longer the friend, as the stock is now clearly in decline with what appears to be massive resistance at 44. When a stock is rallying, valuation doesn’t matter as much as when it is in decline. Growth investors, unless they get a reason soon to stick around, may decide that this cat ain’t bouncing. The bid from value investors is nowhere near the current quote. As you can see in the chart below, the stock has underperformed COLM (and the market) since peaking in the second half of 2007, though it has outperformed the peer over the past year and been roughly in line over the past two years.

Besides having a relatively high PE, I am not sure what is “wrong” with UA. The thing that sticks out, though, is the very high inventory growth. In 2007, sales grew a very healthy 41%, though slower than the previous year’s 53% expansion. Inventory, though, more than doubled, ballooning to 200 days. To put the situation in perspective, the sales increase for 2007 was exceeded by the inventory growth. Maybe there is a good reason, but this surely may be concerning investors. COLM also experienced high inventory growth – 25%, well in excess of the 5% growth in sales. They ended the year at 125 days.

COLM is certainly not as exciting as UA – slower growth for sure. Still, it is probably a better investment. As you can see in the table below, the stock trades reasonably close to book value and at an extremely low multiple of sales and earnings relative to UA:

I like growth as much as the next guy (probably more!), but there is always a price. In this case, an investor has to accept a PE that is double and Enterprise Value ratios that are triple those of a slower-growing company with similar operating margins. While many will look to the 50% gross margin enthusiastically, I see it as a risk: It is much higher than apparel manufacturers on average. If the company’s sales continue to slow, leaving it with excessive inventory, surely those high margins will decline. In that case, the operating margin will drop sharply. For purposes of estimating a downside scenario, applying sales growth of “just” 20% would yield revenues of $727mm (well below the $765-775mm guidance). Assuming a drop in GM to 49% and some deleveraging of operating expenses, the OM could drop to 15%. In that scenario, the EPS would close to the 2007 level of 1.05 and well below the consensus of 1.28. Applying a still relatively high PE of 20 would yield a price of about 21 (a decline of 40%). While this is just a “risk” scenario and not necessarily the likely outcome, I wouldn’t discount it in a recessionary environment such as we are experiencing.

Bottom-line: UA, though it could rally as high as 44 in the short-term due to the market’s rally, is in decline and nowhere close to a level that will draw in a different set of investors should their results disappoint in the coming quarters.

Disclosure: No position in any securities mentioned