Shares of struggling athletic apparel maker Under Armour (NYSE:UAA) dropped again recently on two major events. First, The Wall Street Journal reported that the SEC and DOJ are probing Under Armour’s accounting practices. Second, on the heels of that report, Under Armour released third-quarter numbers that topped expectations, but also included some red flags on the revenue-growth front.
The accounting probes and slowing growth trends spooked investors. In response, Under Armour stock shed 15%. The shares now trade near their lowest levels of 2019.
Taking a step back, I think this big drop of UAA stock is a buying opportunity. There are three reasons for my bullish stance:
- Even assuming UAA’s growth slows going forward, Under Armour stock looks fundamentally undervalued around $17-$18.
- The perception of Under Armour stock will improve from today’s depressed levels.
- The technicals imply that UAA stock is spiraling into oversold territory. That’s a bullish contrarian indicator.
As a result, I like Under Armour stock on this dip. Over the next few quarters, there’s a pretty good chance that it will rebound.
Under Armour Stock Looks Undervalued
The first reason to like UAA stock on this dip is that its shares look undervalued at their current levels, even if today’s slowing growth trend persists for the foreseeable future.
The athletic apparel market is generating non-cyclical growth, expanding at a steady 5%-7% annualized rate, thanks to a favorable shift by consumers to more comfortable, more athletic apparel styles.
Under Armour has been a lagger in the sector. Its revenues have increased at a 2%-4% annualized rate over the past three years. Most investors and analysts expected Under Armour’s growth slump to end. Instead, Under Armour has remained stuck in this growth slump for a long time.
So Under Armour may continue growing 2%-4%, even though its sector is expanding 5%-7%. In the foreseeable future, that’s especially likely, since one of Under Armour’s biggest growth drivers — NBA superstar and Under Armour athlete Stephen Curry — has been sidelined with an injury.
But, even assuming Under Armour does grow at just a 2%-4% pace over the next few years, it still has enough margin drivers to sustain sizable profit growth over the next few years. Moreover, the company’s gross margins improved more than two percentage points in Q3.
Given those points, I still think the company’s earnings per share can reach $1.40 by 2025. Assuming a forward price-earnings multiple of 25 (about average for athletic-apparel stocks) and a 10% annual discount rate, that equates to a 2019 price target for Under Armour stock of $18+.
Thus, below $18, Under Armour stock looks undervalued.
The Perception of Under Armour Stock Will Improve
The second reason to like UAA stock on this dip is that the perception of the stock should materially improve over the next few months.
Right now, the perception of UAA stock is negative. A high number of the company’s top executives have left over the past several quarters. Among those who have departed is the longtime CEO and face of the company, Kevin Planck. Then, investors finally found out why there’s been so much turnover: the SEC and DOJ have been looking into Under Armour’s accounting practices for the past several years.
That’s bad for the perception of UAA stock . Investors, quite reasonably, don’t want to buy a stock with those problems.
But it’s important to note that the DOJ and SEC probes have been going on for several years, and that Under Armour has been cooperating fully and in a timely manner with investigators. It’s also worth noting that its “creative accounting” may have been used to slightly inflate its revenue or profit in a few quarters, but there’s only so much it could have done. At the end of the day, its main trends will remain largely unchanged.
As a result, investors’ current gut reaction to the SEC/DOJ probes is an overreaction. Eventually, the hysteria will calm, investors will understand that the probe is a relatively small issue that has been hanging around for a while, and Under Armour stock will bounce back.
The Shares Are Technically Oversold
The third reason to like UAA stock on this dip is that its technicals are flashing a contrarian bullish indicator.
Specifically, Under Armour stock is now flying into oversold territory, and running into support in the $16-$17 range that’s held for a year. The shares have been in this position twice before — in late December 2018 and late August 2019. Both times, UAA stock proceeded to reverse course around these levels and power higher over the subsequent few months.
Given the company’s fundamentals and the likelihood that the perception of the shares will improve, it looks like Under Armour stock is positioned to stage a similar turnaround rally again.
The Bottom Line on UAA Stock
Under Armour isn’t a great company. But it’s a decent company in a great space. Right now, UAA stock is being valued as if Under Armour is a bad company in a bad space. This discrepancy is an opportunity, and buying Under Armour stock on weakness now should ultimately pay off over the next few months.
As of this writing, Luke Lango was long UAA.
