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Wed, February 8 at 8:00PM ET

Under Armour Is Finally Fixing Its Branding Problem

Under Armour (NYSE:UAA) stock plunged in July after the struggling athletic apparel maker reported second-quarter earnings that were pretty awful. But that’s not the end of the story of UAA stock.

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Source: Sundry Photography / Shutterstock.com

Revenues dropped 40% year-over-year, paced by huge declines across the globe. North America revenues fell 45%. International revenues dropped 37%. Profit margins got slaughtered. What was a narrow operating loss a year ago, turned into an adjusted operating loss wider than $100 million in Q2.

Management also reported that, while June and July traffic trends improved, overall traffic volumes in stores that reopened remain well below where they were a year ago. To that end, management sounded a cautious tone about sales trends for the rest of the year. Gross margins are also supposed to come under significant pressure in the second half as management moves to clear inventory.

Head to toe, it was a pretty bad earnings report. It should be no surprise that UAA stock plunged in response to the ugly print.

But there was also one big positive from the earnings report: Under Armour is finally taking all the right to steps to fix the huge branding problem that plagued this apparel company for several years.

This big positive makes UAA stock a buy on the dip – despite ugly prevailing sales trends today. Here’s why.

A Big Problem

For years, the athletic apparel space was on fire as consumers pivoted toward more broadly wearing comfy athletic shorts, leggings and tees in all lifestyle settings.

But, while the likes of Nike (NYSE:NKE) and Lululemon (NASDAQ:LULU) reported huge growth quarter after huge growth quarter, Under Armour has not. Sales in 2019 rose 3%. They rose just 4% in 2018, and 3% in 2017.

That’s anemic growth for this industry.

What’s going on? Branding problems.

Specifically, because Under Armour missed the boat on the athleisure trend, the company tried desperately to play catch-up in 2017, 2018 and 2019 by selling a ton of product into lower-priced channels, like Kohl’s (NYSE:KSS), on the idea that selling discounted product would increase brand reach.

It didn’t.

Instead, all it did was dilute brand equity, because when consumers started seeing Under Armour shorts and tanks pop-up in Kohl’s stores next to yesterday’s forgotten apparel brands, they started to affiliate Under Armour clothes with “cheap” and “uncool.”

They stopped buying UAA product. Demand globally fell off a cliff.

Fixing the Big Problem

Amid the novel coronavirus pandemic, Under Armour is finally fixing its huge branding problem.

That is, the pandemic gave management the time to reassess the brand’s go-to market strategy, and they’ve come away with the right conclusion. In order for Under Armour to succeed in the long run, the company needs to improve brand equity, and stop selling so much product into off-price channels.

Throughout the second quarter conference call, management talked about reducing brand exposure to the off-price channel. They are re-elevating brand equity by building out a more robust direct-to-consumer (DTC) sales channel, with premium product, at premium prices.

Those are the right moves to be making.

Getting UAA product out of Kohl’s and other off-price channels will help remove the negative stigmas that hampers Under Armour today. Building out a robust DTC channel will help Under Armour more strictly control, and thereby optimize, the shopping experience. Doing so will boost brand equity.

After all, Nike pivoted aggressively to DTC, too. Lululemon is entirely DTC. Both of those brands leveraged strong DTC experiences to cultivate powerful brand equity.

In order to facilitate this transition to premium and DTC, Under Armour is pushing a bunch of product into the off-price channel in the second half of 2020 to clear inventory. Of course, that will kill gross margins over the next few quarters. But it will also give Under Armour a clean slate to build a solid premium DTC business starting in 2021.

In other words, Under Armour is taking all the right steps today to ensure that the company’s growth trajectory meaningfully improves over the next few years.

UAA Stock is Cheap

UAA stock is dirt cheap today because of the aforementioned branding problems.

But, if Under Armour can leverage a premium, DTC pivot to fix those branding problems, then UAA stock today is too cheap for its own good.

That’s because management successfully pulling off this pivot will have two huge financial implications.

First, it will meaningfully accelerate revenue growth, from 3% to 4% today, to 5%-plus over the next few years. Second, it will meaningfully improve gross margins through a bigger mix of full-price sales and create visible runway for operating margins to scale to 10%.

If those two things happen – and I think they will – my modeling suggests that Under Armour will do about 95 cents in earnings per share by 2025.

Consumer discretionary stocks typically trade at 20-times forward earnings. Based on that multiple, a reasonable 2024 price target for UAA stock is $19. Discounted back by 8.5% per year, that implies a 2020 price target of nearly $14.

That’s about 40% above where share trade hands today.

Bottom Line on UAA Stock

Under Armour has been a loser in the red-hot athletic apparel space for years. But this losing streak may come to a close soon. Management is taking all the right steps to improve Under Armour’s brand equity, by pivoting away from the off-price channel and toward premium, DTC channels.

In so doing, management is laying the foundation for Under Armour’s growth trajectory to meaningfully improve.

If the growth trajectory does meaningfully improve, UAA stock is so cheap that it could soar. Quickly. By 40% or more over the next six months.

So buy the dip in UAA stock. This beaten-up apparel stock is ready to rebound.

Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been recognized as one of the best stock pickers in the world by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm.  As of this writing, Luke Lango was long UAA. 

Article printed from InvestorPlace Media, https://investorplace.com/2020/08/under-armour-is-finally-fixing-its-branding-problem/.

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