In early December, I highlighted Under Armour (NYSE:UA, NYSE:UAA) stock as a potential 2020 rebound candidate, saying that valuation and operational tailwinds could breathe life back into shares of the athletic apparel maker.
But, there is now one problem with that 2020 bull thesis: UAA stock rallied nearly 15% in December 2019. That’s a big rally in a short amount of time. And, it has entirely changed the bull thesis on the stock. A month ago, UAA was trading at a discounted valuation. Today, though, the valuation appears full. With the discounted valuation part of the bull thesis now gone, Under Armour stock doesn’t look all that compelling in 2020 anymore.
In other words, a big portion of the 2020 rebound has already been realized in December 2019. That leaves shares with minimal upside potential over the next year.
All else equal, then, I think now is a good time to take profits on Under Armour stock.
Under Armour’s Fundamentals Will Improve
Calendar 2019 was a messy year for Under Armour. Sure, UAA stock rose more than 20%, which by itself, constitutes a good year. But, Nike (NYSE:NKE) rose more than 30%, Adidas (OTCMKTS:ADDYY) rose nearly 60%, and Skechers (NYSE:SKX) and Lululemon (NASDAQ:LULU) both rose about 90%. Thus, relative to peer athletic apparel names, Under Armour was a big underperformer in 2019.
This underperformance was the byproduct of three things. First, revenue growth rates slipped, as the company’s international business meaningfully slowed. Second, slowing revenue growth caused margins to slip, as positive operating leverage turned into negative operating leverage. Third, negative optics from a federal investigation into the company’s accounting practices as well as C-Suite turnover weighed on investor sentiment.
Those three headwinds will reverse course in 2020, paving the way for Under Armour’s fundamentals to materially improve.
Revenue growth rates should rebound, led by stabilization in the international business as geopolitical tensions ease and consumer spending trends pick back up. A weaker dollar should also help boost sales in 2020. This revenue growth rebound will once again drive positive operating leverage, as expense growth rates should not change heading into the new year. At the same time, the multi-year-old federal investigation into the company’s accounting practices could very likely come to an end over the next few quarters.
Big picture — the things which caused underperformance in UAA stock in 2019 will reverse course in 2020, and the fundamentals underlying this company will go from bad to much better.
Under Armour Stock Is Fully Priced
Fundamental improvements alone do not make a stock a strong buy. Instead, fundamental improvements and a discounted valuation are the necessary ingredients for a strong buy stock.
A month ago, Under Armour stock had both of those. Today, it only has one.
In early December 2019, Under Armour stock was trading at $18. That was a sizable discount to my 2020 price target for the stock of $22.50, which was based on a few long-term assumptions. First, steady 3%-4% revenue growth over the next few years thanks to sustained athletic apparel market tailwinds, offset somewhat by slight market share erosion because the brand continues to emphasize performance over fashion. Second, continued margin expansion from gross margin improvements and consistent positive operating leverage. Third, earnings per share growth to $1.50 by 2025, driven by low single-digit revenue growth and significant margin improvements.
My long-term assumptions for Under Armour’s growth trajectory have not changed over the past month. The price tag on UAA stock has. A month ago, this was an $18 stock, with 25% upside potential in 2020. Today, it is a $21.50 stock, with much less compelling 5% upside potential in 2020.
Because of this, UAA stock no longer looks that great heading into 2020. Yes, fundamental improvements will drive shares higher. But, a full valuation will limit the magnitude and challenge the sustainability of those gains.
Bottom Line on UAA Stock
A month ago, UAA stock looked like a great rebound candidate for 2020, with 20%-plus upside potential over the next 12 months. But, it has since rallied 15% in a month. Yet, the long-term fundamentals underlying shares have not changed.
Thus, the big 2020 rebound in UAA stock has mostly played out in late 2019. Over the next 12 months, UAA stock will likely be choppy, with fundamental improvements being offset by valuation friction.
As of this writing, Luke Lango was long NKE.
