Under Armour (NYSE:UA, NYSE:UAA) shares moved higher after the company’s earnings report on Feb. 12. Both classes of Under Armour stock gained. As of this writing, UA shares are up 6% and UAA stock is higher by 7.4%.
The divergence in performance adds to the long-running — and still unexplained — valuation gap between UA and UAA shares. But the fact that both classes of Under Armour stock have rallied itself is odd. Q4 earnings were solid, admittedly. But guidance for 2019, which should matter more to a forward-looking market, was left unchanged.
With UAA stock already up 18% before earnings, the report hardly seems strong enough for more upside. And it leaves Under Armour stock, which I thought was a sell in December, in a precarious position going forward.
Under Armour Stock Rises After Earnings
In terms of expectations, Under Armour earnings admittedly look solid. Adjusted earnings-per-share of 9 cents was 5 cents better than consensus of 4 cents, and a noted improvement from a breakeven performance the year before. Revenue rose 1.5% to $1.39 billion, about $10 million ahead of the Street.
Expectations aside, however, the performance is hardly impressive. Sales in North America dropped 6% year-over-year in Q4, driving a full-year 2% decline in that market. Given that Nike (NYSE:NKE) has executed a dramatic reversal in its North American business, Under Armour is clearly losing share domestically. Questions persist surrounding the company’s retail strategy of selling full-price at outlets like Dick’s Sporting Goods (NYSE:DKS) and at a discount at Kohl’s (NYSE:KSS).
There is good news, admittedly. International sales continue to grow nicely. Those markets — now about a quarter of total revenue — are key to the long-term strategy. And Under Armour is recovering some of the margins it has lost in recent years, with its adjusted gross margin up 160 bps in Q4.
Bulls, then, can argue that Under Armour’s turnaround is progressing. That’s actually true. But to at least some extent that’s already priced in. And looking at guidance for 2019, it’s a surprise that Under Armour stock has continued to rally.
Guidance and UAA Stock
At its Investor Day in December, Under Armour laid out five-year targets for its turnaround. The market wasn’t impressed. Under Armour stock had already fallen heading into the report, and it continued plunging afterward. The two declines combined led Under Armour stock down 30% in less than three weeks.
Obviously, broad market weakness in December didn’t help. But even considering a notable change in sentiment for the market as a whole, the rally in UAA stock on Wednesday made little sense. The stock already had recaptured much of those losses, but little changed in the story on Wednesday looking forward. The 2019 outlook was reaffirmed. Under Armour still sees EPS of just 31 cents to 33 cents this year, implying a 67x price-to-earnings ratio (on the high-end of guidance) for UAA stock.
That single metric doesn’t make Under Armour stock a sell. But the rally of the past few weeks does seem confusing and potentially unsustainable. It was the long-term outlook in December that spooked investors. That outlook suggests something like $1 in EPS in 2023. Yet UAA stock now trades at 22x that long-term figure.
More notably, UAA now has recaptured all of the post-Investor Day selloff. That seems like too much. Luke Lango wrote at the time that the outlook confirmed that $20 was too much to pay for UAA stock. The stock now is over $22. What drives more upside?
The Risks to UA and UAA
The aggressive move in UA and UAA of late creates two key risks. The first is that in 2019, Under Armour now has to outperform. If five-year targets weren’t enough in December, and they haven’t changed since, then investors are pricing in better-than-expected results. Any quarter going forward that isn’t a big beat is likely to lead to a selloff in Under Armour stock.
The second risk is that UAA stock also looks reliant on broad market trends. What is now a 26% rally year-to-date is coming solely from the fact that investors are more bullish in 2019 then they were at the end of 2018. When that bullishness fades — or again reverses — UAA will be left in a precarious position.
Again, this is not to say that there’s no good news in Under Armour earnings. The turnaround is on track. International sales and margin expansion are key parts of the story.
But this is also a company losing market share in North America, where revenues in 2019 are expected to be flat and its stock is trading at 60x+ 2019 earnings. A turnaround of some kind is already priced in. From these levels, for UAA to gain, the progress needs to accelerate. And it’s not clear why investors see the Q4 report as evidence that acceleration is on the way.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.