Under Armour Might Need A Deeper Moat

| About: Under Armour, (UAA)

Under Armour (NYSE:UA) is a leading developer, marketer, and distributor of performance apparel, footwear, and accessories. Their moisture-wicking fabrics are engineered in various designs and styles for wear in nearly every climate to provide a performance aspect to traditional athletic apparel products. Under Armour products are sold worldwide and are used by athletes at all levels - from youth to professionals, as well as by consumers with active lifestyles.

The large majority (94%) of Under Armour products are sold in North America, but their products are also sold in countries around the globe, including China, Austria, Germany, Panama, Spain, and the United Kingdom. A third-party licensee sells their products in Japan and distributors sell their products in other foreign countries.

Under Armour apparel comes in three lines - HEATGEAR® for hot weather, COLDGEAR® for cold, and ALLSEASONGEAR® when it's just right outside. Also, each gear line comes in three primary fit types - compression (tight fit), fitted (athletic fit), and loose (relaxed fit).

In 2006, the company started offering footwear. The footwear segment includes products for football, baseball, lacrosse, performance training, running, basketball, and hunting.

The 2012 product segment breakdown was apparel 76%, footwear 13%, and accessories 9% of net revenues. Licensing arrangements for the sale of their products represent the remaining 2% of revenues.


Under Armour has a solid balance sheet, with a debt-to- equity ratio of 7.6%. Current ratio is 3.6. Inventory control has tightened, with inventories decreasing 1.6% (EOY 2011 to EOY 2012) while net revenues increased 24.6% over that same time period.

Those increasing revenues were accompanied by a slight decrease in gross margins (48.4% to 47.9%), which the company attributes to the sell-off of inventory at reduced prices in 2012, and a larger proportion of lower-margin footwear sales. The company also cites higher freight costs and supply chain issues for the margin squeeze. But for a decrease of only 50 basis points, maybe "squeeze" is too strong a word. They're holding steady.

The stock isn't cheap - it sports a P/E of around 40. By comparison, Adidas (OTCQX:ADDYY) has a P/E of around 31, Columbia Sportswear (NASDAQ:COLM) is around 19, and Nike (NYSE:NKE) weighs in at about 25. The question then centers on Under Armour's prospects for growth. (UA PEG Ratio is 1.6.)

I think Under Armour is a great company with a great line of products. The management has shown a propensity to look beyond the horizon and expand into new areas. Having found success initially with football related apparel, they expanded into a women's line, a camouflage line for outdoorsmen, and on into footwear.

The challenge for UA will come when they start expanding to the extent that they start stepping on the toes of their larger competitors. UA's fastest growing segment is footwear, but they're still only selling $239M to Nike's $13.4B in that arena (FY 2012). As UA continues to grow, they will draw more competitive attention. You've got to be either better or cheaper than your competition, and being cheaper than Nike at producing a quality product is difficult due to Nike's considerable economies of scale. So UA will need to differentiate their products as being better.

The Moat

This brings me to my concern about UA. There's no question that, through a combination of deft design, R&D, and marketing strategies, UA has carved out a niche in a very competitive industry. Their products look good. They function well. They're cool. They have a strong, expanding consumer base.

But here's the thing. A huge part of the UA success story has to do with how the product is different - how it performs differently (and better) than the more traditional products of competitors. Under Armour products help you stay warm and dry when it's cold, and cool and dry when it's hot. That superior performance has everything to do with technological advancements. So you would assume that UA has protected those advancements with patents. Right?

Not so much. The company's latest Annual Report (filed 2/25/2013) states:

The fabrics and technology used in manufacturing our products are generally not unique to us, and we do not currently own any fabric or process patents.

The intellectual property rights in much of the technology, materials and processes used to manufacture our products are often owned or controlled by our suppliers.

Should this be a concern? I think, at the very least, it is a consideration. The moat isn't very deep when pieces of their technology could be for sale to a deep-pocketed bidder. There are some very deep pockets out there. And for UA, the technology is a huge part of the equation for their success. What if they lost their technological advantage?


Great company. They sell a product that's in high demand and they have a loyal, growing legion of consumers. They are expanding their product lines and they continue to find new and exciting ways to market their products.

The stock, however, requires a more balanced view. The fundamentals are strong, and the company has a proven track record for growth and profitability. But that will cost you. Anytime you pay north of a 35 P/E for what is basically an athletic apparel company, you are taking some risk. Even if it's very good athletic apparel. And the moat may not deter the competition if/when UA starts to take a bigger share from its larger competitors.

For many, Under Armour presents a risk/reward ratio that suits their investment strategy. For me, I'll wait for a significantly lower entry point to balance the risk. That lower entry point might not come - but that's the game, isn't it?

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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