Has Under Armour Stock Really Peaked?

  • Under Armour split releasing class C to shareholders and perhaps making their equity more attractive to smaller investors.
  • With a wave of competition capitalizing on the athleisure trend, Morgan Stanley has reiterated a sell rating on Under Armour.
  • Although they appear to trade at a premium, Under Armour has lived up to their valuation by performing with consistent growth.

Following Under Armour's (NYSE:UA) stock split in which shareholders received newly issued Class C shares, investors might be more enticed to purchase ownership at the 50% reduced share price. However, Morgan Stanley disagrees.

One of Under Armour’s biggest challenges lies in grabbing a share of the women market. While Under Armour believed they would be able to grow their brand among women to the point at which it would account for half of their sales, they may find out that it’s not so easy. We are moving deeper into the athleisure trend – years deeper. This is not a fad that will last forever, but certainly one that has drawn a lot of attention in the apparel industry. All the leaders have seen a significant boost due to this new fashion trend, however Under Armour experienced significantly more growth than most. With a 3-year revenue growth rate of 29.3%, Under Armour is simply on fire.

So, why is Morgan Stanley reiterating a sell?  Like I said, we are years into the athleisure trend and competitors have come in strong. For Under Armour to spread like wildfire among women is difficult to do when they have Nike (NYSE:NKE) breathing down their necks, or Lululemon Lulu (NASDAQ:LULU) seeing big growth and becoming the trendy fashionable athletic standard in the female market. While the fashion trend continues and the demand remains, the competition is becoming plentiful, and that is going to make it harder for Under Armour to continue with their current growth rate.

Valuation

Trading at a PE of 78, Under Armour, has been priced for its growth rate for quite a while now. At first glance, you might think that they are a young software company by looking at their valuation multiples. However, when you realise they are an apparel company it might draw a red flag. But while Under Armour may appear to trade at high valuation multiples, they have walked the talk with incredible growth along their top and bottom lines. Below I’ve outlined a DCF for Under Armour using a 10% discount rate and 5% terminal growth rate.

UA-dcf

As you can see, I do have Under Armour’s value of equity below their current market capitalization by approximately 11%. However, it is important to note that the model will have its flaws. Projecting the growth rate of such a fast growing company is difficult, but I believe the growth I used was fair. Under Armour has seen and is expecting to see some modest improvements in their operating margin.  I used their current margin of 10% and scaled it up to 12%, which hovers around the industry average of 11.4%.

Under Armour’s operating margin could end up closer to Nike’s 14%. However, from an investor’s perspective, I think that 12% is a fair assumption. And, of course, one of the biggest difference makers is Under Armour’s tax rate of 39%, which is more than twice as high as that of Nike who sell far more overseas at lower taxation. Although I used Under Armour’s historical tax rate to remain conservative along their bottom line, it is likely to see that rate drop a few points in favour of the investor.

Conclusion

I understand where Morgan Stanley analysts see the risk in Under Armour stock. The company is definitely valued at a premium and their ability to retain their growth momentum and gain significant market share among women is still questionable. Their current debt is pretty low, but it is likely to grow as it looks like they may be facing some liquidity challenges with a cash ratio of just 0.27.

Nevertheless, Under Armour stock has performed consistently. Every few months someone comes along who claims that the apparel company shouldn’t be valued so high because they can’t retain the growth to catch up to its valuation, and yet Under Armour just keeps performing. Morgan Stanley analysts are saying what others have been saying for a while now, and so far it hasn’t worked.

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