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| Photo from: www.businessinsider.com |
I’m not one for fashion trends, do pardon me if I’m late to take notice,
but I’m starting to realise how Under Armour has become so much more prevalent
locally. Under Armour has become the byword for trendy apparel, quality
sporting equipment and being hip and cool.
This new, refreshing and sporty image the brand portrays has found its
way to our shores, where not only dudes of my age but 40-something uncles are swapping out their last-generation Nike
apparel for a piece of this amazingly cool brand. While I don’t speak for nor
care very much about fashion trends, the question that came to me was this: Is Under Armour stock as cool as Under Armour
apparel?
Some Background:
Under Armour (UA) is an American sports clothing and apparel company, founded by Kevin Plank in 1996. From a tiny business Plank begun in the basement of his grandmother’s house in Washington DC, Under Armour grew to become what it is today – an international sporting apparel company that rivals the likes of Nike and Adidas. From a one-man operation in a basement, Under Armour now hires more than 11,000 people globally.
The company went public in 2005 for $6.50 a share, which hit an all time high of $52.67 in 2015,
translating into returns of more than 700% in this 10 year period. [Adjusting for the
2-for-1 stock split in April 2016] However, shares have fallen since then, to
close under $40 as of 9 September 2016.
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| Chart from: www.nasdaq.com |
Because analyzing charts makes for more interesting discussion that
talking about bone-dry numbers, I shall perform some technical analysis on UA
stock. [FYI: I’m looking at the Class “A” shares here, not the Class “C” shares
which trade under the ticker “UA.C”]
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| Chart from: www.stockcharts,com |
Looking back 6 months, we see that UA has been on a bit of a roller
coaster ride. The stock ranged from as high as $48 to as low as $36, with a one
year historical volatility of 42%. Technically, the numbers are rather clear to
the eye, with resistance in the high $43s, where UA has formed a double-top
formation since July, while light support (blue horizontal line) is in the
vicinity of $39, a level which UA just punched through.
Actually, the strong move downward on Friday 9/9 didn’t only break
support, it also slam dunked through the trendline connecting the late June and
early August lows. This is extremely bearish for UA.
However, I expect further downside to be limited in the short term as both the Stochastics
Oscillator (my settings are set to slow) and CCI in oversold territory. Unless
there is a sharp selloff in the broader market, I think UA is likely to
consolidate around $36-$37 in the short term.
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| Chart from: www.stockcharts,com |
Taking a longer term view on the weekly 2 year chart, a different
picture of the court is painted. Connecting the 2016 highs and lows, we see
that UA is stuck in consolidation in a wedge formation, with prices bouncing
between both trendlines. Without a clear breakout in either direction, I
believe UA will continue to remain in consolidation mode and therefore I am
neutral on UA on this timeframe.
And now, time for the numerical stuff.
Looking at the “scoreboard”
Unfortunately folks, this may not be as exciting as the scoreboard in a game of basketball. But financial reports serve the same purpose of telling you how the “game” is going.
2011
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2012
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2013
|
2014
|
2015
|
|
Revenue*
|
1470
|
1830
|
2330
|
3080
|
3960
|
EBITDA*
|
197.67
|
251.78
|
318.15
|
427.25
|
519.29
|
Net Profit*
|
96.92
|
128.39
|
162.17
|
208.04
|
232.57
|
FCF*
|
(41.01)
|
149.11
|
32.24
|
78.51
|
(343.03)
|
Net Profit Margin
|
6.59%
|
7.02%
|
6.96%
|
6.75%
|
5.87%
|
EPS
|
0.47
|
0.62
|
0.77
|
0.98
|
1.08
|
NAV/share
|
$3.09
|
$3.94
|
$4.99
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$6.36
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$7.76
|
ROE
|
15.2%
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15.7%
|
15.4%
|
15.4%
|
13.9%
|
ROA
|
10.5%
|
11.1%
|
10.3%
|
9.91%
|
8.10%
|
*Figures
in Millions of USD Data obtained from MarketWatch
To make it easier on your poor eyes, I’ve decided to compile the data
into several easy to read graphs.
*All figures in Millions of USD
At first glance UA’s 5 year performance looks fantastic. Revenues have nearly
tripled, net profit has more than doubled. However, there is more than
meets the eye. EBITDA and net profit seem unable to keep up with soaring
revenues, indicating lower profitability.
More worrying is the free cash flow (FCF) figure, which has no discernible
trend and seems to oscillate between positive and negative. Free cash flow is
used to determine the profitability of the company’s core business, without the
accounting gimmicks that calculate net profit. FCF paints a much darker picture
than the increasing net profits may suggest. It seems that the company is unable to generate more cold hard cash despite what its revenue growth may suggest, and is at times, bleeding cash.
*All figures in percentages
A look at financial ratios gives a more revealing picture. Net profit
margin has shrunk from 6.6% in 2011 to 5.9% in
2015. So simply put, the business has
become less profitable as it grows
larger?
Both return on equity (ROE) and return on assets (ROA) give insight on
the managerial effectiveness of UA, being metrics commonly used to gauge this
aspect of performance. Both ROE and ROA have fallen over this 5 year period,
possibly indicating trouble brewing
beneath the surface. Reading between the lines, the overall financial leverage
of the company has also increased, since ROE can also be calculated by ROA
multiplied by financial leverage.
In essence what these figures are telling me is that management has struggled to make the
company more profitable over the past five years. Taking on more debt
(therefore increasing leverage) has not helped performance but rather seems to
have the opposite effect.
Time Out?
Just like a rising star in NBA, Under Armour, being a growth company, is under constant pressure from investors and shareholders to keep up its performance. Investors have run up the stock to frothy valuations, with a trailing P/E Ratio at 36 and a P/B ratio at nearly 5, indicating their sky-high expectations for future growth. With all the growth and hype already priced into the stock, UA is under pressure to deliver.
Looking at its most recent fiscal year 2015, we see some cracks beginning
to form under the surface. Looking beyond the record high revenues, EBITDA, net
profit and NAV/share numbers, we see that profitability ratios have declined
rather substantially. The most alarming figure, buried deep in the financial
report, is probably the negative $343 million of free cash flow. UA also
reported its first negative cash flow from operations (CFO) figure, which is
stunning given that its CFO figure was steadily increasing throughout the 4
years prior.
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| Screenshot from www.marketwatch.com |
While management has addressed these concerns in its annual report (see
below), the sudden large increase in its changes in working capital number from
2014 (2014: -138m, 2015: -508m) does raise some
eyebrows.
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| Screenshot from Under Armour's 2015 Annual Report |
Another notable number is the massive
increase in capital expenditures (capex), which management assures is used
to fund their new headquarters and invest in the expansion of their business. This
intense spending on capex and acquisitions (more on that later) is funded by
the issuance of new debt and an established revolving credit facility, to push
for rapid expansion. However, with falling profit margins in 2015, perhaps the
effects of such aggressive debt-funded expansion have not been felt, or have
not been given sufficient time to blossom. As with all debt-funded
growth, it pays to be careful as an investor and be on the lookout for potential red flags.
Mid-season transfers
Just like an NBA team looking to sign better players, UA has been on an acquisition spree in recent years. In 2015 alone it spent in excess of $560 Million to acquire Endomondo, a Denmark-based digital connected fitness company, and MyFitnessPal, a digital nutrition and connected fitness company, to expand its Under Armour Connected Fitness community.
As mentioned, the cool $560 Million it
needed to cough up for the acquisition spree was funded by more debt as well as some cash on hand. However, the main
focus here is not the amount paid, it’s the companies they paid the big dollars
for.
Connected fitness basically means cool geeky fitness gadgetry that
tracks stuff like your heart rate and rest cycle. That stuff goes along very
well with the stuff they usually sell (athletic shirts and shoes). Right now,
these acquisitions seem to make sense, being somewhat a case of horizontal integration. It also
diversifies the business away from selling sporting apparel, which hopefully
creates another steam of income.
It’s also an attempt to level the playing field with larger competitor,
Nike, which is already rather established in this aspect. More on comparing
with big boy Nike later.
Curry favour
With NBA MVP Stephen Curry at the helm of their advertising, marketing efforts at UA seem to be extremely successful in reaching an international audience. Not only has it created brand awareness, I believe Under Armour has become a big name in sporting apparel. UA in sporting fashion has become what Abercrombie and Fitch is in fashion – a young, hip and cool brand that is highly desirable and comfortable to wear. The UA logo on one’s chest gives one an added sense of confidence and perhaps even some “street cred”. Suddenly, the random stranger decked out in UA that challenges you to basketball looks a lot more legit than the one decked out in Nike.
UA has also become something like a status symbol, or rather, fashion that
conspicuously demonstrates one’s wealth, with a majority (49.9%) of customers in the USA having an annual
household income of between $75,000 and $149,999,
and 17.1% of customers with an annual household
income of more than $150K. Desirability is one
key reason why the UA brand sells.
Under Armour’s relentless marketing campaign has paid off spectacularly,
laying the groundwork for future sales and expansion. What is of critical
importance here then, is that this publicity translates into expectations-beating sales and revenue
figures for the company, which has been the case so far, if you ignore the
bottom-line.
The Underdog?
In any sporting league there is bound to be a dominant team, and in the
world of business it is no different. While sporting apparel brands are aplenty
(think Nike, Adidas, and all the new brands from China), I am only going to
focus on comparison with the dominant
brand in the marketplace, fellow American competitor, Nike.
With a market capitalisation value of $94 Billion, Nike (NYSE:NKE) is 10 times bigger than underdog Under Armour, with a market cap of
about $9 Billion. Nike is also a
much more established company, having begun operations more than 50 years ago. It
is not what one would call a growth company, having reached a humongous size
and scale of operations globally. However, since this is not a piece of
analysis of Nike, I shall not delve into its financial figures too deeply.
Being a company of such size, its revenue and net profit figures run in
the billions of dollars (compared to millions
for UA). Comparing them to those of Under Armour would be like comparing apples
and pears. Therefore, I’ve used financial ratios instead to make common ground
for comparison.
Nike
12-month Trailing P/E
Ratio
|
Price-to-Book Ratio
|
Price-to-Sales Ratio
|
Net Profit Margin
|
Return on Equity
|
Return on Assets
|
26
|
7.58
|
2.96
|
11.6%
|
30.1%
|
17.5%
|
Under Armour
12-month Trailing P/E
Ratio
|
Price-to-Book Ratio
|
Price-to-Sales Ratio
|
Net Profit Margin
|
Return on Equity
|
Return on Assets
|
37
|
10.4
|
4.49
|
5.87%
|
13.9%
|
8.10%
|
Comparing at the P/E, P/B and P/S ratios, Under Armour seems to be trading at lofty valuations. Being a
growth stock, hyped-up investors have already
priced in its future growth into the stock, explaining UA’s higher
valuation multiples compared to Nike.
With net profit margin, ROE and
ROA all at less than half that of its competitor, Under Armour seems to be performing badly. In fact, it’s hard to
believe that UA even has a chance to catch-up with Nike, falling behind on so
many fronts. It also goes to show that Nike has an excellent management that
can deliver consistently good results.
Based on these 6 valuation metrics alone, Under Armour looks rather overvalued compared to Nike, not
to mention that it underperforms its
larger competitor in every aspect here. In summary, investors are valuing an
inferior company more than the superior one, simply because the underdog has greater growth potential. Should it fail
to deliver on expectations, UA stock could take some serious beating.
Final verdict
As spectacular as its meteoric rise may be, Under Armour stock clearly does not
deserve a “Buy” rating at this point in time. Its fundaments are
mediocre and the technical side of things doesn’t give a clear indication of
future price trends.
The stock is overvalued, driven by investor expectations rather
than solid fundamentals. Should there even be a slight quiver in the upward
trajectory of its admittedly-amazing growth, Under Armour stock could face serious downside as investor
expectations recede and valuations pare to more justifiable levels.
Would I invest my money in Under Armour now? The short answer is, NO.
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