Problems Persist At Under Armour, But Cash Flow Improves

| About: Under Armour, (UAA)

Athletic apparel giant Under Armour (NYSE:UA) reported strong fourth quarter results January 31. Revenue jumped nearly 26% year-over-year to $506 million, exceeding consensus expectations. Earnings were in line with consensus estimates, growing 52% year-over-year to $0.47 per share.

For more than a year, we've been cautious about the way the apparel firm has been managing its cash flow. After a warm fourth quarter in 2011, the company was saddled with large amounts of product that strained liquidity through most of the year. However, 2012, and more specifically, the past two quarters, represented a push in the right direction. Under Armour's inventory declined year-over-year during the third quarter, and we once again saw inventory decline 2% year-over-year during the fourth quarter. More recently, Under Armour has been able to send slow-selling products through its outlets, resulting in a much cleaner balance sheet at year end. We're very encouraged to see the company with $342 million in cash (up 95% year-over-year) and ample opportunities to make new investments.

Under Armour is also doing a fantastic job containing costs, with SG&A declining 370 basis points as a percentage of revenue to 34.2%. Marketing costs declined 120 basis points to 9.7% of sales, and we don't expect marketing costs to weigh on profitability in the near term. SG&A will be a bit elevated during the first quarter of 2013, but management expects meaningful expense leverage (a reduction in SG&A as a percentage of sales) in the second and third quarters of the year.

Apparel once again was Under Armour's strongest-performing segment, with revenue advancing 23% year-over-year to $1.4 billion. Continued popularity and innovation via new products such as storm and charged cotton are making the firm less reliant on weather cycles, and more of a technical fashion company, a la Nike (NYSE:NKE) and Lululemon (NASDAQ:LULU). Compression is now just 14% of revenue (was 65% when the firm went public), and we like that the firm continues to diversify its revenue stream.

On the surface, footwear looked strong, with revenue growing 43% year-over-year to $45 million. That growth rate sounds great, but we tend to think footwear is the primarily culprit weighing on the company's gross margins, which fell 130 basis points compared to the prior year. We've previously shown investors the abomination of a shoe that was supposed to be Under Armour's flagship basketball model, but the shoe has largely received negative reviews as it continues to sit on shelves. One of the men responsible, and one of CEO Kevin Plank's "key industry hires," Gene McCarty (SVP, footwear), announced his resignation, and we think the company knows it needs to head in another direction. Plank acknowledged the company's past failures in footwear, and even noted how the firm has had trouble impressing wholesale buyers, saying:

"And it's things like what we're doing with Footwear and when people walk into our stores, they'll say, "My gosh, I had no idea you made all these styles and colors and you were so broad." It's because a lot of this has been -- people living with a footwear brand, we were maybe 2 or 3 or 4 years ago. And so we see the ability to really accelerate that as well as to our consumers, and frankly, to our wholesale partners as well and demonstrate to them what our brand has the ability to look like at retail."

Footwear is a really hard business to do profitably, in our view, and while the company notes solid gains in baseball cleats, breaking into the basketball and running markets remains the missing link to make the company a real competitor with Adidas and Nike. We're interested to see what happens with the new strategy in place.

Overall, we were very pleased with Under Armour's fourth quarter results and outlook. Revenue is anticipated to grow 20% to 21% in 2013, with operating income growing 22% to 23% during the year. We like the firm's improved cash-flow conversion in 2012, and we think the company will continue its solid growth trajectory this year, despite shortcomings in footwear. We believe the company's shares look fairly valued at current levels, and think opportunities in our Best Ideas portfolio offer greater upside potential at this time.

Disclosure: I 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.

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Tagged: , Textile - Apparel Footwear & Accessories, Earnings
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