A week ago, in very uncharacteristic fashion, sporting apparel and shoe juggernaut Under Armour Inc (UA, UA.C) lowered its full-year sales guidance and booked an impairment charge due to the loss of an important customer.
The stock, which had already been weak this year, fell some 5% and is down more than 31% from its yearly highs.
The valuation is far from bargain-basement levels, but rarely falls to that point for world-class companies such as Under Armour.
There are some longer-term concern to consider, but right now investors are trying to discern if the near-term problems are just a hiccup and the stock drop represents a rare buying opportunity.
What’s Affecting UA Stock?
Under Armour’s share trading activity has been weak lately but is indicative of shorter-term negative news that has little to do with its highly compelling future direction.
Overall retail malaise is causing investors in the industry to question the distribution channels for buying products — sporting goods included. Internet-based firms such as Amazon.com, Inc. (AMZN) continue to take share from brick-and-mortar businesses. Traditional department store chains are faring the worst, but most retailers are struggling as consumers increasingly migrate to buying their goods online.
Due mostly to the anemic trends at its major customers, Under Armour’s shares have fallen to lows over the past 52-weeks. Investors are worried about current sales trends, and these are valid concerns right now. Dick’s Sporting Goods Inc (DKS), which accounts for some 11.5% of Under Armour’s total sales, is struggling somewhat and expects flat sales for its full fiscal year.
However, Dick’s is struggling because its weaker rivals are closing shop. This is also affecting Under Armour, and there are two primary reasons for this.
For starters, the weaker players, including Sports Authority and Sports Chalet, are liquidating and sending cheap merchandise flooding on to the market. Fortunately, this won’t last long.
Under Armour also suffers in the near term by losing these two sizeable customers for good. Management updated its guidance for the year on the loss of Sports Authority as an account. Due to Sports Authority’s bankruptcy, it will realize only $43 million of the $163 million in sales it planned to this account for 2016.
Why the Company Continues to Turn Heads
Under Armour is a small, but incredibly nimble company. Its mission is simple enough: to help athletes perform better.
It has done this for 20 years now by taking a scientific approach to developing apparel and performance gear that it continually tests and analyze to make better for a demanding customer base of athletes. The public has taken notice of the gear and constitutes the bulk of daily purchases across the globe.
The end result has been incredible returns for shareholders. Sales up are tenfold in the last decade; they were only $431 million in 2006 and are on pace to reach around $5 billion this year. The stock has trounced the market return every year since 2011, making this year a rare miss that could reverse course.
Another Near-term Uncertainty
Back in March, Under Armour issued a new class of stock that could very well confuse investors. For every share of class A and class B stock held by shareholders, it issued a share of class C stock. This essentially let founder and CEO Kevin Plank, who owns the class B stock, maintain an ownership stake of 15%.
The new class C shares don’t have any voting rights and will likely be the primary share class issued going forward. This means that Plank’s B shares won’t be subject to further dilution, and will let him keep his voting power even in the face of offering employees stock options and making future acquisitions.
Given Under Armour’s stellar track record, it’s hard to argue with Plank staying firmly in power. It’s also a widely adopted strategy for company founders to keep their control. Google founders used the approach (they also attempted to make the company’s non-Google operations more understandable) when changing the name to Alphabet and issuing new share classes.
Yet, the strategy can end up causing problems. Look no farther than Viacom, whose aging founder Sumner Redstone is fighting to stay in power well into his 90s. Certain family members and company executives are questioning his mental capacities given his advanced age.
Are the Shares a Good Deal?
The share price is right around $37 per share — well below annual highs of nearly $53 back in September. The earnings multiple has obviously dropped too, but at a forward price-earnings of about 64, hardly qualifies the stock as a steal at current levels.
But keeping in mind this is a preeminent growth stock, the earnings multiple for the 2017 looks somewhat better at 47. Plus, annual sales growth is expected to return to 20%-plus levels, right where it has been on average over the past decade and is expected to remain.
The risk to a high valuation is the stock could fall off a cliff if sales and profit growth fall. But 2016 looks to be a single off year for Under Armour, and indications are the firm’s long-term fortunes are strong enough for investors to make money in the stock.
The Growth Outlook Is Great
The key question (as with any company!) is how fast growth is likely to be going forward. If Under Armour’s past is any indication of the future, prospective investors have little to worry about.
A decade ago, earnings per share were just a dime and jumped to 53 cents in 2015 for an average growth rate above 40%. According to a discounted cash flow analysis, if Under Armour can grow profits for 35% a year for the next five years, then finally starts to slow down in its more advanced age, the stock is worth closer to $40 per share.
That’s less than 10% above current levels, but there is the potential for earnings to continue their torrid growth trajectory for another decade, or more. UA is just getting going in casual sportswear and expects its footwear to grow more than 40% a year for the foreseeable future.
Internationally, it sees a runway for 50% annual growth through at least 2018. Today, more than 90% of sale stem from North America. By 2018, Under Armour estimates this will be below 80%, as brand awareness increases outside of its home turf.
Under Armour, at a $5 billion sales level, is still considerably smaller than archrival Nike Inc (NKE), which is projected to log nearly $33 billion in sales this year. And analysts think it can grow 15% a year from here on out. Indeed, the market for sports apparel and footwear is about $250 billion annually and leaves plenty of runway for growth for the two leaders in the industry.
Under Armour’s smaller size and current popularity suggest it can outperform Nike and keep shareholders happy for many years to come. CEO Plank is only 43 and should be around for at least another decade. Given his track record, shareholders should welcome his continued participation and ability to maintain his voting control.
A final, and important consideration is e-commerce, or online sales. To combat the struggles at traditional retailers, Under Armour is focused on reaching new and existing customers via the internet. 57% of its digital traffic is on mobile devices, which is where consumers increasingly shop for clothes and footwear.
All in all, Under Armour appears to have the right strategies to continue its rapid growth. I think it is reasonable to use the recent share price dip to establish a modest initial position, or add to your existing holdings.
As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.