Under Armour's Investment Case Improves After Fourth Quarter Earnings

|
About: Under Armour, Inc. (UA), UAA
by: BAM Investments
Summary

Under Armour's stock saw significant appreciation after reporting 4th-quarter earnings due to expanding margins.

International growth, fewer promotional activities, and inventory optimization were largely responsible.

Trends are expected to continue with 2019 guidance, which should lead to additional stock gains; however, execution remains a significant risk.

Investment Thesis

Under Armour (UAA, UA) is an innovative company with a premium brand that has faced margin issues as a result of growing pains and a competitive athleisure marketplace. The company has begun to reverse these issues and is showing signs of a turnaround. Given this, I think Under Armour’s stock has room to appreciate; however, don’t be surprised if there are selloffs on the way due to lack of execution.

Introduction

When Under Armour reported 4th-quarter 2018 results, the stock was rewarded by the market. Despite revenue only growing 1.5% year-over-year to $1.39 billion (3% increase on a constant currency basis), the company was able to beat non-GAAP and GAAP earnings per share estimates by pretty large margins. As a result, at points during the release day, the stock was trading nearly 8% higher than the previous day. It has been a difficult recent history for Under Armour facing various headwinds that have really hit the stock price hard and have set expectations low. The 4th quarter signaled life to the Street and provided optimism for 2019, but should investors be excited? Here’s a breakdown of the company’s earnings:

North America Slump

Despite the increase in revenues, the company is continuing to contract in North America, where sales were down 6% to $965 million. The North American athleisure market has become highly competitive and saturated with options (even by brands not in the sports apparel business). Additionally, the trends appear to be slowing down as consumers are growing a preference for jeans and boots again. While this will slow down the general public’s purchases of athleisure apparel, Under Armour needs to ensure that they are focusing on active athletes that will remain when the general population moves on to another fad. I believe Under Armour is positioning itself for this by performing “North American cleanup in 2018”. This involves optimizing inventory to better follow demand, normalizing pricing, and promotional activities, and sharpening the company’s product segmentation strategy. By doing this, the company will resurrect the Under Armour brand that demands a premium and improves the bottom line.

Inventories, Gross Margins, and Operating Costs Improving

That’s exactly what it did in the 4th quarter of 2018. Gross margin increased 160 basis points to 45% even after including $2 million in restructuring costs. The improvement is being driven by the sales mix, product cost improvements, lower promotional activity, and lower air freight costs; partially offset by foreign currency fluctuations. Even from a Sales, general and administrative cost perspective, the company was able to decrease by 1% to 42.3% of revenue. Cutting costs was a clear goal of management’s for the company to reclaim success. The first step was optimizing inventory, which they were able to do in the 4th quarter of 2018 as inventory was down 12% to only $1 billion. This is key as excess inventory results in promotions, lower sales price, more air freight costs, and an unquantifiable hurt to the company’s brand image. Under Armour must carry this margin momentum into 2019.

2019 Guidance

The company held its guidance that was released at the company’s Investor Day in early December 2018. Revenue is expected to increase by 3% to 4% for the full year. The growth, similarly to Q4 2018, is being driven by the International market while trying to hold the North American market flat. Gross Margin is expected to improve by 60 to 80 basis points from 2018 due to sales mix, less promotional activity, improved supply chain, and more Direct to Consumer (DTC) sales. Ultimately, these targets should allow the company to achieve an operating income in the range of $210 million to $230 million compared to a $25 million loss in 2018. Aside from reducing costs and improving margins, the top line drivers to this guidance in 2019 will be the DTC and International efforts.

Direct To Consumer Growing

In 2018, DTC revenue was up 4% to $1.8 billion, which represents 35% of the company’s total revenue. The channel is expected to be up at a mid-single-digit rate in 2019. Management is focused on increasing this business given the higher margin opportunity. This is being achieved through more frequent product releases, mobile site optimization, customization, personalization. This is the future as the company expects DTC to become a larger mix of sales over the next 5 years. This not only impacts the North American market, but it’s also driving International growth.

International increasing

The International market has become the company’s growth driver with the North American market holding flat. In 2018, the International market was up 23% to $1.3 billion versus the North American market declining 2% to $3.7 billion, which represents more than a quarter of the company’s business. This was a result of increasing in several markets including EMEA (up 23% neutral), Asia-Pacific (up 27% currency neutral), and Latin America (up 8% currency neutral). As the sales base gets larger, management expects to slow slightly in 2019 with low double-digit growth guidance. The growth opportunity comes from expanding retail locations and servicing additional country websites in order to give customers access to the products.

Conclusion

Under Armour was able to provide optimism with the 4th quarter earnings release. It showed that the company can improve margins by optimizing inventory and reducing promotional activities. It also proved that the International markets are a source of future growth as North American sales stabilize. Both initiatives are supported by 2019 guidance. Under Armour has always been able to successfully innovate products; however, it has lagged on the business side of things. Given the strong product and these turnaround signals, I think Under Armour’s stock has room to appreciate; however, don’t be surprised if there are selloffs along the way due to lack of execution.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in UAA 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.