Growth Company Shopping List For A Declining Market: Part 1- Under Armour

Oct.27.12 | About: Under Armour, (UA)

I do not claim, nor will I ever, to know where the broad markets are heading between here and the year's end or at any point in time for that matter, though it is apparent that any strong upwards trend in the overall markets has been stymied at least for the time being due to several issues. These include (but are not limited to) the decline in top-line growth reported by many companies so far this earnings season, the looming fiscal cliff, and ongoing woes in Europe.

However, I am a firm believer that all investors, whether in the market currently or looking to find an entry point, should have a shopping list ready. This is of particular importance in an uncertain or declining market like we have had in recent days.

Overall market declines have the ability to weigh on individual companies, which has the potential to provide sales and attractive entry points into these stocks that may otherwise not have presented themselves. However, it is important to do one's homework to make certain the decline is caused by external pressures on stock prices, and not fundamental declines in the business itself.

Over the next couple of weeks, I intend to share the growth companies that head up my own personal shopping list, companies that I have had on my wish list for some time that I may look to initiate a position in should further declines and opportunities present themselves. It is my hope that these articles will raise awareness in what I believe to be solidly run companies with plenty of room for growth while at the same time stimulating well-thought and well-intended debate such that we can all come to the most educated investment decisions possible.

A company that I have long followed, but have yet to own is Under Armour (NYSE:UA). I published an article on Seeking Alpha on September 7th, 2012 briefly highlighting several positives the company has achieved over the years, but voicing my concerns about entering the stock at then current valuations. In fact, as a value investor, valuation concerns have thus far precluded me from buying the stock (and I must admit at times from profiting in it as it has been a really well-run company). In the article, I cautioned investors to consider taking some profit off of the table at that point, and to consider waiting for a better entry point if looking to initiate a position in UA.

The stock was trading at values around the $59-$60 range at the time of my September 7th article. However, since the time of that writing, the stock has declined in intra-day price to just around the $50 range at the time of this writing, a decline of a little more than 15% give or take. This led me to review recent company documents, conference call transcripts, and results and to strongly question if I would finally like to initiate a position in the company.

Let us briefly look at recent company results from the most recent quarter, including some highlights from the earnings conference call:

· The company managed to increase net revenues by 24% to $575 million in the 3rd quarter of 2012, while also improving margins to 48.7%.

· This allowed for a 23% increase year over year in diluted earnings per share to $0.54.

· Under Armour demonstrates cash and equivalents on hand of $157 million at the quarter's end

· Simultaneously, Long-term debt at the end of the quarter declined to $72 million

Additionally, the company updated its full year 2012 outlook and 2013 outlook based on current visibility:

· Full year guidance for 2012 was reiterated at the high end of prior guidance.

· This includes 2012 net full year revenues of $1.82 billion, an increase of 24% y.o.y.

· Also includes operating income of $207 million, an increase of 27% y.o.y.

· 2013 outlook for net revenues at the lower end of company target growth range of 20-25%.

· 2013 outlook for operating income to fall in the mid-range of the same 20-25% range.

· Also expecting moderate full year operating margin improvements.

These items are encouraging to me for a variety of reasons. Given recent tendencies of companies to slash guidance, particularly revenue guidance, (if you have been following earnings season relatively closely you will be familiar with many decreases in projections), I am pleased to see that Under Armour has projected to the high end of full year 2012 guidance, while maintaining a pretty positive outlook for 2013. In fact, I believe that had expectations not been so high for the company and had macro issues not weighed on markets in recent weeks, the stock may not have declined much if any with recent guidance. However, that is a discussion for others.

This affirmed guidance is positively compounded when viewed in the following light: UA has managed 10 consecutive quarters of 20% top line growth, and 12 consecutive quarters of 20% growth in its main apparel business. Simply great results. I particularly like that management says there were balanced contributions from the men's, women's, and kid's apparel segments, indicating that the company is doing a good job of widening and monetizing its available consumer base.

It seems that UA has really begun gaining traction in the shoe market, and additionally has outlined a very clear vision as to the next growth areas in the shoe business. Look at the following quote from the recent conference call:

"The strong acceptance we saw this past quarter for our spine footwear technology, and the fact that Cam Newton Highlight cleat was the single most compelling on-field product at retail in 2012 is great evidence that our thought leadership has raised consumers' expectations for Under Armour footwear"

Compelling in and of itself, but I am interested in the growth areas management believes this will open for them. Namely, the Cam Newton cleat is going to be followed up with an UA Highlight Trainer training shoe with a price point of $150. This shoe will be "inspired by the iconic look of the game shoe."

They are also planning an expansion of the Spine platform, which seems to have been gaining traction already.

This is very exciting to me, considering the company is only in its 7th year in the footwear business. The conference call states that its cleats business is already "very significant" and growing, and the company believes it is just hitting its cadence in the running shoe department, though it only has "low single digits" market share in this department. However, the running shoe business is a $6 billion category in the U.S. alone, according to UA transcript, and the company has much room to expand its current offerings against more established players such as Nike (NYSE:NKE). I personally believe the Under Armour brand is gaining ground in terms of recognition and is poised to take market share in this area.

It is worth noting that the company is beginning to plant seeds overseas, with the establishment of a relationship with Tottenham Hotspur Football Club in London and its first stores in China. However, while I think these are important first steps in establishing the brand in foreign markets, I would be surprised if these areas are earnings drivers in the near future.

To avoid rambling more than I already have, I will sum up my positive spin in this way: The company is doing a very nice job of driving growth in apparel in all categories (Men, Women, Children), and seems to be gaining a secure toehold in the shoe and cleat world (no pun intended). The company has continually demonstrated 20% plus growth and is projecting it to continue into next year in an environment that is causing many, many public companies to slash guidance. The stock has finally receded some 15% in the last few days, and may finally be presenting a buying opportunity that is comfortable to me.

So, let us review my old source of consternation very briefly. Valuation.

The current full year EPS estimates, based on Yahoo Finance data, are for $1.20 per share. However, if one looks specifically at Q4 estimates and adds them to year to date EPS, one comes up with full year EPS closer to $1.35. At a price of $50.50 today, this creates a P/E ratio range at year's end of something between 37 and 42. For argument's sake, I am assuming UA will manage the upper end of the EPS range as noted, yielding a P/E ratio of 40 or slightly below (assuming a $51 stock price). This is significantly below the P/E approaching 60 I mentioned back in early September 2012. But it can still not be called CHEAP when compared to growth in the range of 25% or maybe slightly over on the bottom line numbers. But it is of course much, much 'cheaper' than what it was, and these high growth companies will always carry a premium valuation.

My bottom line: The recent decline is beginning to entice me as an entry point around $50. However, while the stock is cheaper than it was 7 weeks ago, it still carries a premium valuation to some extent. After factoring in consistency, reiterated nice growth numbers for 2013 in a tough environment, and strong management, I believe the stock warrants an investment.

My advice would resemble this game-plan: I feel fairly comfortable purchasing a small portion of my desired position in UA at the $50 mark. However, I would be prepared to ease into the water and buy with fairly wide scales on the way down in an effort to average down cost. I will probably look to buy 15-20% of my position around current levels, and use fairly wide scales with additional declines for additional purchases in gradually larger quantities until I have established a position I am comfortable with at a cost average I am happy with.

I realize that I may never establish my "full" position if the stock finds a bottom soon, but I for one am OK with missing a portion of the upside if it allows me to miss most or all of the potential down moves. As always patience is a virtue in investing (not trading). I also encourage all to do their own homework regarding investment decisions. This article is intended to spark thought and intelligent debate, not convince any individual to follow my own thesis to the letter. I invite all commentary and thank you for it!

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in UA over 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.