Shares of athletic apparel company Under Armour (NYSE:UAA,NYSE:UA) got a big boost on Friday after long time bearish analysts at Wells Fargo lifted their rating on the stock from “Underperform” to “Market Perform”. Wells Fargo cited declining clearance sales, strengthening marketplace inventory, restructuring EPS benefits in 2019, and relatively low Street expectations as reasons why the worst is over for UAA stock.
But, I don’t think that’s the case. From where I sit, the worst does not appear to be over for UAA stock.
There’s still a lot not to like about Under Armour stock. North American growth remains anemic. International growth is still cooling. Margins are way down, and need to rise by a lot in order to make the current valuation seem sensible. Meanwhile, underlying fashion trends remain adverse for Under Armour, and the outlook for a huge revenue rebound remains bleak.
Overall, the worst may not be for UAA stock just yet, meaning the recent rally may be one worth fading.
Under Armour Has A Lot Of Problems
Recent quarterly numbers from Under Armour underscore that this company still has a lot of problems.
Back in 2015-16, UAA was a big growth brand stealing mind and market share from bigger players like Nike (NYSE:NKE) and Adidas (OTCMKTS:ADDYY). At that time, Under Armour had a robust and increasingly popular athlete portfolio headlined by Stephen Curry, Jordan Spieth, and Cam Newton. North America revenue growth was running in the 20%-plus range. International revenue growth was up above 50%. Gross margins were close to 50%. Operating margins were around 10%. Most importantly, brand relevance was high.
Almost everything has changed about the UAA growth narrative since then.
Under Armour is a low growth brand losing mind and market share to Nike, Adidas, and Lululemon (NASDAQ:LULU). Under Armour’s former headline athletes (Curry, Spieth, and Newton) are losing popularity. North America revenue growth was negative last quarter and has been oscillating between slightly positive and slightly negative for several quarters now. International revenue growth was 17% last quarter, and rapidly falling. For the full year, gross margins are expected to be around 45%, and operating margins are projected at 3%. Most importantly, brand relevance is low.
Overall, there are still a lot of problems at Under Armour. Until those problems are resolved, the worst is almost certainly not over for UAA stock.
Those Problems Aren’t Getting Better
None of these problems are showing signs of improving any time soon.
Search interest related to Under Armour has been a solid leading indicator of UAA stock over the past five years. See the attached chart, which graphs year-over-year growth in search interest (with a 3 month delay and displayed as a 10-week moving average) next to UAA stock price.
The results are pretty astounding. Every major move in Under Armour stock over the past five years has been accurately predicted by search interest trends three months prior. Moreover, the implication is clear. UAA stock has spiked recently. But, search interest trends remain weak.
Also, the outlook for margins to improve dramatically isn’t all that great. Under Armour has been aggressively pushing product through lower priced channels to offset a rapid sales slowdown in North America. The net result is lower gross margins. Granted, gross margins may rebound from currently depressed levels. But, with so many sales now going through Kohl’s (NYSE:KSS) as opposed to Dick’s Sporting Goods (NYSE:DKS), it’s tough to see gross margins getting back to 50% due to brand dilution.
Thus, in the big picture, revenue and margin trends will remain weak for the foreseeable future.
The Valuation Is A Tough Pill To Swallow
The big problem with Under Armour stock is the valuation. This stock trades at over 70x forward earnings, versus a 25 forward multiple at Nike and a 32 forward multiple at Lululemon. Moreover, both of those companies are growing revenues at a significantly faster clip than Under Armour.
The rationale behind the big valuation is potential for a huge margin rebound. But, as detailed earlier, margins aren’t going to rebound back to their peak any time soon. As such, today’s valuation is pricing in something that realistically won’t materialize.
Because of this, the worst is not over for UAA stock. You have a richly valued stock with still weak top-line growth prospects and limited margin expansion potential. That combination will ultimately lead to further weakness in the stock.
Bottom Line on UAA Stock
Although the athletic apparel sector is supported by favorable growth tailwinds, Under Armour stock is unattractively priced considering its large valuation and “last place standing” in the athletic apparel industry. Because of this unattractive pricing, the worst is not over for UAA stock.
As of this writing, Luke Lango was long NKE, LULU, and DKS.
