- Under Armour reported a bumper fourth quarter where footwear was one of the fastest growing division.
- Inventories dropped for the fourth quarter although they were still substantially up from 2014.
- The run-up in Under Armour stock price has it at valuations that are currently far too rich for me.
Under Armour stock rocketed higher to $84 a share (a 22%+ move) after announcing its fourth quarter earnings of $0.48 a share on revenues of $1.17 billion handily beating analysts expectations on both counts. Furthermore, guidance for 2016 was strong in the eyes of Wall Street. Under Armour (NYSE:UA) is guiding 4.95 billion in revenues along with $503 million in operating income.
Under Armour stock price rally has spiked the price to earnings ratio to 86 and the forward price to earnings ratio is still hovering around the 50 mark. The company's footwear line saw exceptional top line growth. Sales grew by 95% to reach $167 million for the quarter and new recruit "Steph Curry" was named as the chief reason for the explosion of sales in this division.
However, the question remains whether Under Armour stock justifies its current valuation and warnings signs are emerging that it may not. For example, top line growth is not coming through to the bottom line. Net income grew at 10% slower rate (21% growth) than the top line in the last quarter which warrants caution.
Furthermore, as discussed in my earnings preview article here, I noted inventories were growing at a much faster clip than the company's top line which meant that the Q4 footwear hype was merely a story of liquidation of product at cheaper prices. In saying this, Under Armour will undoubtedly grow convincingly from here but too much of that growth has been already priced in which I why I wouldn't entertain entering Under Armour stock at these valuations.
First of all with the closing of the balance sheet for 2015, there are definitely some worrying signs that investors need to watch out for. Under Armour's cash position has slipped to $129 million which is now more than 3 times less than its receivables metric. Furthermore, inventories have spiked to $783 million (even though they dropped in the fourth quarter) meaning these two metrics are increasing far faster that top line growth. Investors must remember that Under Armour is being marketed as a premium brand as it uses the likes of
Investors must remember that Under Armour is being marketed as a premium brand as it uses the likes of Jordan Spieth and Steph Curry to charge top dollar for its products. The problem the company currently has is that repeated selling of footwear for example at discounted prices is going to affect the prestige of the brand. Many premium companies offload product quietly in order to maintain the prestige of the premium brand.
Under Armour doesn't have the balance sheet to do this which is why operating margins will continue to suffer unless the company addresses the problem swiftly. Why? Well Under Armour gear ended up being sold in deep discount stores such as TJ Maxx during the holiday season. This doesn't add up especially if the company is paying millions of dollars every year to its portfolio of athletes through endorsements.
The company is also facing headwinds at present at some of its key retailers. Macy's (NYSE:M) where Under Armour derives 2% of its income is presently closing stores while another key retailer (Sports Authority - contributing 8% of sales) could be facing bankruptcy in the near future. Both of these retailers make up 10% of Under Armour's revenue but the company is taking swift action by opening up 200 new physical stores in 2016.
Most of these stores will be outside the US (predominantly China) which makes sense given the much higher growth rates in the east plus the huge room for expansion ( only 12% of sales come from International markets). However the long term risk I see with Under Armour's business model is how the company front loads its products (through huge marketing efforts) and then hopes these ongoing launches (involving celebrities) will continue selling the product in question for months and years thereafter and therein lies the problem in my opinion. The marketing model is both short term and trend focused and I just feel the company hasn't taken into account the
The marketing model is both short term and trend focused and I just feel the company hasn't taken into account the long term costs such as product development, expansion, marketing which will be needed if it is to compete with the likes of Nike (NYSE:NKE) and Adidas over the long term.
If we look at the technical chart, we can see that Under Armour stock had difficulty maintaining momentum yesterday (29th of January) after its 20%+ move on the previous day which was earnings day. The 50 weekly moving average may have provided the resistance but it was still discouraging to see a perceived high growth stock only rally 1.7% when the S&P500 tacked on almost 47 points.
Furthermore, the weekly moving averages have not crossed so we cannot assume that a new intermediate rally has begun in earnest. In my opinion, an entry at the 200 weekly moving average level ($53 a share) would be as much as I would pay for the stock. Buying Under Armour stock at $53 would mean you are buying Under Armour with a p/e multiple of just under 50 (based on 2015's EPS number of $1.08) and a forward multiple of 37 (based on $1.35 EPS projections for 2016.). Ultimately I see higher capex spend and flat gross margins (which management has already guided for 2016) taking its toll on Under Armour stock's performance eventually.
To sum up, Under Armour's earnings looked great on the surface but long term risks remain. The cash position has decreased substantially on the balance sheet and Q4 footwear sales were mainly due to liquidating inventories at lower margins. Furthermore, the company's products ended up in discount stores over the holidays which will damage its premium brand if continued over time. Finally, promotion of products is very launch and trend focused. It definitely works in the short term but the company needs to build log term equity which will require more long term marketing plans.