It’s gone from one of the hottest names to the S&P 500’s biggest loser. How it can rise 30% in a year.
Under Armour is under pressure during what should be its moment to shine. The brand has never been more closely attached to high-profile sports. On Saturday, the University of South Carolina’s Gamecocks will become the first basketball team to wear Under Armour gear to the Final Four, the semifinal college championship round.
Outfitting deals like that resonate with shoppers, who are big fans of the brand, judging by a recent survey, or a visit to any campus or gym. A new deal with
Kohl’s (ticker: KSS) could mark the start of expanding sales beyond ballers and Crossfit types to the athletically disinclined—a lucrative market for
Nike (NKE) and
Adidas (ADS.Germany). Relative to those industry bigs, Under Armour (UAA) also has plenty of room to grow in overseas markets and footwear.
Yet investors hate the stock. Under Armour is the single worst performer in the Standard & Poor’s 500 index over the past year, down 55%. The stock peaked 18 months ago at $53 a share. It recently fetched just $20.
Shares have nonetheless multiplied five times in value since they first began trading in November 2005. But sales have multiplied 17 times since then. Why is a company that is lighting it up at the cash register getting trounced lately on the trading floor? There are several reasons, including growing pains, missteps, and retail turmoil, but one stands above all others: The stock was simply too expensive to begin with.
On average over the past five years, Under Armour has traded at more than 50 times forward earnings projections. It is only slightly less expensive on that basis now, but that is misleading, as earnings estimates have been slashed by half in a year. Sales are more telling, because they have been stabler. Under Armour traded recently at 1.6 times sales estimates, half its average of the past five years. On that basis, it is 15% cheaper than the broad S&P 500 and more than 35% cheaper than Nike.
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Sources: Apex Marketing Group, NCAA Graphic by: William Davis
Whatever Under Armour’s challenges, it is likely to grow sales at a double-digit clip for years to come, versus a single-digit one for Nike, simply because Under Armour has so many markets left to fully tap. Contrarians who buy the stock here could make 30% or more in a year. There is a caveat: Nike went through a remarkably similar slowdown 30 years ago, when it looked a lot like Under Armour does now. It obviously rebounded and went on to produce stellar gains for long-term holders. But its slump lasted years. Under Armour will have to step nimbly if it is to bypass the slow road to recovery.
BALTIMORE-BASED UNDER ARMOUR started as a simple idea. CEO and founder Kevin Plank, not a particularly big or fast linebacker for the University of Maryland football team in the mid-1990s, wanted to do something about the discomfort and extra weight of his sweat-soaked cotton T-shirts. He used $17,000 saved from a flower-selling business, plus $40,000 of borrowing power on his credit cards, to buy synthetic fabric from a nearby supplier and hire a tailor to craft his first snug, moisture-wicking designs, and began handing out shirts to top college athletes and equipment managers. His headquarters were in his grandmother’s townhouse in Washington, D.C.’s Georgetown neighborhood. The first order, for $3,800, came from Georgia Tech. Sales the first year totaled $17,000 but topped $1 million three years later. Plank used sales proceeds and credit, rather than equity partners, to fund expansion, one of the reasons he maintains control of the company today. Another reason is that one year ago, Under Armour issued nonvoting shares that have left Plank with 15% of the economic stake, but 65% of the vote.
Orders from pro teams followed, and the publicity proved lucrative. Athletes look good in Under Armour’s form-fitting shirts and shorts, which makes for its own kind of marketing to fans and kids’ leagues. Today, Under Armour has yearly sales of around $5 billion, versus $34 billion for Nike and $21 billion for Adidas. Worldwide, the sportswear industry, including shoes, is estimated at $282 billion, including the U.S. market at $104 billion. Sportswear has been growing much faster than other clothing, and industry forecasters expect the trend to continue beyond the end of the decade.
Just as striking as Under Armour’s rapid ascent is its room for gains in key areas. In its core market, the U.S., it sells through 13,000 stores, largely sporting-goods chains, versus 23,000 for Nike. Footwear accounts for only 21% of sales. For Adidas it is 39% and Nike, 61%. International is 16%, versus half for Nike and more than 80% for Adidas.
Under Armour is also relatively small in women’s clothing and so-called lifestyle apparel, whether it’s athletic designs for leisure wear or nonathletic items like boxer shorts and canvas low-top sneakers.
THERE HAVE BEEN FASHION misses. Last year’s all-white Curry 2 Low Chef sneakers, named for pricey brand ambassador Stephen Curry of basketball’s Golden State Warriors, were the butt of gleeful ridicule on Twitter and television chat shows. Critics called them just right for shuffleboard players, emergency-room nurses, and middle-age dads. One tweeter suggested renaming them the Prostate Exam 7s and distributing them through AARP’s phone app.
It happens. The 2007 Nike Lebron 5 basketball shoe was derided as a climbing boot. Many sneaker aficionados consider Adidas’ 2001 Kobe 2 the ugliest model of all time.
Curry 2s notwithstanding, Under Armour doesn’t seem to be struggling in footwear. Sales there jumped 36% from the total a year earlier. International sales are also soaring from a low base, up 55%. Neither of those two categories is big enough yet to make up for a sharp slowdown in North American apparel, which brought overall North American growth down to 5.9% last quarter, from more than 25% a year earlier. Management chopped its guidance for this year, too.
IS UNDER ARMOUR FALLING out of fashion? Not according to Jefferies analyst Randal Konik, who upgraded its shares to Buy from Hold on March 24, calling them a top pick and raising his price target from $19 to $27. His firm’s survey of 2,000 consumers suggests that the Under Armour brand has strengthened over the past three years and that demand for athletic wear remains robust.
To Konik, there is a clear reason for the company’s stumble last year: Adidas made a massive market-share gain with some popular retro styles. That trend has peaked, and Under Armour is poised for faster growth going forward, according to Konik. Sentiment on the stock is extremely negative. One-quarter of the shares available for trading have been sold short, or bet against. That’s the highest percentage of any stock in the S&P 500.
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Sources: Apex Marketing Group, NCAA Graphic by: William Davis
There is another simple explanation for Under Armour’s slowdown: sporting chains going bust. The Sports Authority and Sports Chalet threw in the towel last year. A smaller chain, MC Sports, folded earlier this year. To the victors—
Amazon.com(AMZN), to be sure, but also
Dick’s Sporting Goods (DKS)—have gone the spoils, in Dick’s case a quick rise in same-store sales growth. But not all of the lost sales have migrated elsewhere. Some were likely impulse buys of discretionary items—wants, not needs—that aren’t coming back. That has left clothing brands, including Under Armour and Nike, chafing under excess inventory in need of clearing out. On the other hand, it raises the prospect of growth rates picking back up once inventories are lean.
LET’S DISPENSE WITH ONE investor distraction: Plank calling Donald Trump a “real asset to the country” during a February television interview, drawing some disagreement from key partners, including Curry, who tweeted in response, “only if you remove the ‘et.’ ” Sam Poser, who covers the stock for Susquehanna Financial Group, downgraded it shortly after, writing that a controversy like that makes it “nearly impossible to effectively build a cool urban lifestyle brand.” Plank took out a full-page advertisement in USA Today explaining his support for immigration, equal rights, and so on.
As scandals go, this one was a yawner. Plank has learned why corporate chiefs at consumer-brand companies keep their politics quiet. Curry found the right mix of naughty and marketable. And
Gannett (GCI) got some ad revenue out of the deal. We declare it resolved. Plank, whom
Barron’s interviewed for a
CEO Spotlight a year ago, declined to comment for this story.
Another of Poser’s concerns is more troubling. During store checks, he found the Under Armour assortments at Kohl’s well-presented, but with more overlap than he expected with Dick’s, particularly in tops and leggings. Kohl’s has recently been running a 25% off sale on many Under Armour items. “If you’re Dick’s, how do you like that, and what do you do?” asks Poser. Dick’s didn’t respond to requests for comment. For Under Armour, it will be important to carefully segment merchandise across new store chains to avoid rankling top longtime retail partners. UA also has plans to expand into discount shoe chain
DSW (DSW) and privately held Famous Footwear.
There is another matter Poser points out: On its annual financial filing, Under Armour reduced revenue by $2.9 million for a “return credit for footwear” that was not recorded in its earlier filing. It’s a relatively small sum, but the handling seems amateurish. Under Armour’s chief financial officer left in January, one of four top executive departures since October 2015.
That pattern troubles Simeon Siegel at Nomura Instinet, who is also a bear on the stock. But another concern of his is perhaps the most serious facing the company—and athletic brands in general. He views their expenses as “variable and essentially never-ending.” One way companies generate explosive earnings growth is by reaching a point where sales ramp up much more quickly than expenses. But sports brands fight an ongoing battle for sponsorship deals. One reason Under Armour has a team in the Final Four is that it sponsored 12 of the NCAA tournament’s 68 teams, up from five two years ago. The South Carolina deal costs $71.5 million over a decade, which is significant for a company that is expected to book just $188 million in profit this year, albeit a discount to the $280 million, 15-year deal Under Armour signed with the University of California, Los Angeles, last year.
Under Armour is not Amazon. Investors will not endlessly indulge rampant spending in the name of juicing sales growth, as recent trading has demonstrated. The bet-it-all bravado that worked for Plank from his grandmother’s townhouse must now give way to finding cheaper and more scalable ways to grow.
In the company’s third-quarter call with investors, Chip Molloy, the now-departed CFO, said that as revenue approaches $10 billion, investments will pay off in the form of rising operating margins. That could take five years, judging by Wall Street forecasts. In the near term, the fastest-growing segments might not help overall margins, because footwear is structurally less profitable than clothing, and Under Armour’s overseas business has less scale than its U.S. one.
THE GOOD NEWS is that there is precedent for a comeback. Nike has been a fine holding for investors over the past three decades, returning a compounded 21.2% a year, versus 9.9% for the S&P 500. But back in the mid-1980s, it looked a lot like Under Armour does today, according to Wells Fargo Securities analyst Tom Nikic. A 20-year stretch of fast growth had suddenly stalled. There was a competitor—Reebok—taking share. And whereas Under Armour might have been caught flat-footed by the sudden growth in “athleisure” wear, Nike was surprised back then by a shift toward nonrunning fitness activities. It, too, had heavy investments that pulled down margins.
Eventually, Nike found fast growth in shoes for different sports, continued making gains in apparel, shook up its leadership, improved its inventory management, and expanded overseas. But its turnaround took four years, Nikic notes.
Plank has the advantage of being able to study Nike’s playbook, or at least part of it; his leadership team could surely do with less shaking up until investors regain confidence. Although he has built much from scratch, he’s not burdened with having to pioneer a new industry, as Nike was. And while the Internet can be both friend and foe, Nike didn’t have it back then to help with targeted marketing and direct sales. Factors like these point to the possibility that Under Armour can rebound faster than Nike did, but only if Plank can step into the shoes of a passionate entrepreneur who gained big-company savvy, like Nike co-founder Phil Knight.
The risk for investors who buy Under Armour shares now is that the company muddles through a long stretch of weak results and discomforting signals from management, in which case the stock could sag to $15. But a bottoming of sales growth soon, followed by a return to peppier increases, looks more likely.
The shares won’t regain their former multiple to sales anytime soon. But a rise to even a market multiple, against sales that come anywhere close to the $6.1 billion projected for 2018, would send the stock more than 30% higher in a year. It’s not a slam dunk. But the shares are cheap enough to be well worth a shot.
Buyers have a choice of two share classes.
Class A (UAA) are the longest-lived ones, and come with one vote apiece.
Class C (UA) were issued in spring 2016 and have no votes. There are also B shares with 10 votes apiece, but those are owned solely by Plank. Favor the C shares. They represent the same economic stake as the A shares, but they recently sold for about $1.50 a share less. That’s down from an average discount of just over $2.
Under Armour is keen to keep the two share prices similar because it plans to use UA for employee incentives. It changed the ticker from UA.C in December, presumably to boost demand among casual investors. Indeed, the discount has narrowed since then. Class C buyers get no voting say, but Plank’s lock on the supervoting class ensures that they wouldn’t have had much of one anyway.
