Athletic apparel company Under Armour (NYSE:UAA) has been in rally mode recently. First, management provided an update on its restructuring plan, slightly upped fiscal 2018 earnings guidance and sounded a bullish tone on potential operating margin expansion in the long-term due to workforce reduction. That trio of updates sent Under Armour stock flying higher.
Then, Stifel reiterated its “Buy” rating on the stock and J.P. Morgan upgraded Under Armour stock from “Underweight” to “Neutral” on the idea that the company can meet earnings estimates over the next two years.
Under Armour stock jumped on that news too.
All together, Under Armour stock has gone from $18 to nearly $21 in just a few days. But, above $20, Under Armour stock is overvalued. The technicals don’t look great, brand sentiment remains weak and the fundamentals don’t point to much growth going forward.
Given this, investors would be wise to fade the current rally.
Lots Wrong With the Under Armour Story
I follow the athletic apparel space pretty closely and there are lot of good narratives out there which have powered many of these stocks higher.
For example, Adidas (OTCMKTS:ADDYY) is leveraging a return to retro styles and non-sports-celebrity endorsements to transition from an athletic apparel brand to lifestyle apparel brand, a pivot that has caused a surge in mainstream popularity. Adidas stock has likewise surged.
Meanwhile, Nike (NYSE:NKE), after getting its butt kicked by Adidas for several years, is finally fighting back with product innovation, streamlined investments and a focus on direct selling. These moves have caused Nike to regain relevance, and the stock has also rebounded in a big way.
Over at Lululemon (NASDAQ:LULU), the traditional yoga apparel brand is breaking out of its shell and increasing its product assortment to appeal to the non-yoga and male communities. It’s working, and Lululemon stock has been on fire.
But the narrative at Under Armour isn’t anything like the narrative at Adidas, Nike or Lululemon. And Under Armour stock doesn’t have the growth potential that any of those stocks do.
At Under Armour, the narrative is actually quite bleak. You have a brand that was once super-hot, was unable to sustain that momentum and is now trying to regain that momentum through selling in lower-priced channels. But, in so doing, the company is diluting its premium brand image, taking a hit on gross margins, still not seeing much growth in the North America business and relying entirely on slowing international growth to drive sales higher.
The UAA narrative just isn’t that good. So long as the narrative remains broken, Under Armour stock will remain broken too.
Valuation Makes No Sense
Despite Under Armour having the worst narrative in the athletic apparel space, by far, Under Armour stock has the greatest valuation — and it’s not even close.
Nike stock trades at 30 times forward earnings. Lululemon stock trades at 40X forward earnings. Skechers (NYSE:SKX) trades at 16X forward earnings. The whole retail apparel industry trades around 20X forward earnings, while the footwear industry trades around 30X forward earnings.
Under Armour stock? It trades at 120X forward earnings.
The counter argument here is that although Under Armour stock trades at a much bigger earnings multiple, that is only because margins are mega-depressed right now. In terms of price-to-sales, Under Armour stock is actually much cheaper than both Nike and Lululemon. Thus, if Under Armour can improve its margin profile to be on par with Nike and Lululemon, Under Armour stock is actually undervalued.
But that whole argument rests on the idea that Under Armour can get to Nike and Lululemon margins. That will never happen. Nike and Lululemon have always had a better margin profile than Under Armour. Why? Because Lululemon’s premium brand image translates into sky-high gross margins, and Nike’s unprecedented size translates into anemic opex rates. Under Armour is only diluting its brand image and will never get to Lululemon gross margins. Meanwhile, Under Armour’s growth is tapped out at only a fraction the size of Nike, so this company will never benefit from the same operating leverage as Nike.
In other words, investors should forget the price-to-sales multiple. What really matters for Under Armour stock, considering the company’s lack of sustainable long-term margin drivers, is the price-to-earnings multiple. At over 100, versus a 20 to 40 multiple elsewhere in this industry, Under Armour stock’s price-to-earnings multiple makes no sense.
Bottom Line on UAA Stock
I don’t think the stock will drop in a big way because it has found support in the upper-teens over the past several months. But Under Armour stock almost never holds rallies above $20 for that long because the fundamentals don’t support it up there. The same will be true this time around.
That’s why it is time to fade the rally.
As of this writing, Luke Lango was long SKX.
