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Thoughts on Under Armour



April 19, 2014 – Comments (2) | RELATED TICKERS: NKE , UA

Under Armour (UA) is a company I have been closely watching as a potential addition to the Pencils IRA Project portfolio. Under Armour has been an incredible investment over the past several years, increasing 960% in value since 2009. I added the company to my watchlist last month:

Under Armour is guided by founder, chairman, and CEO Kevin Plank, who founded the company in 1996. Under Armour produces a wide of apparel products and sportswear, most notably for athletes. Speaking from personal experience, I have noticed that much of the sportswear worn by Berea College's athletes is in fact made by Under Armour. There is little doubt that this is a well-respected brand growing in popularity. 

Under Armour has seen sales expand at an average pace of 21.68% annually since 2010. This pace actually accelerated last year, with sales increasing 27.09% in 2013 to $2.33 billion. Since 2010 Under Armour's earnings have increased at an average annual rate of 24.08% to $162.33 million in 2013.

I hesitate to open a position in Under Armour at this point largely because of the valuation. The stock trades at a P/E of 70.75 and a P/S of 4.88, with a market cap of $11.23 billion. (This compares to Nike's P/E of 25.27, P/S of 2.37, and market cap of $65.01 million.) Under Armour will have to maintain significant growth rates to lead to market-beating returns over the next 3-5 years. Over the past year Under Armour has traded in a P/E range of approximately 50-80, and the P/E tended to stay in the range of 40-60 in the two years prior to 2013. So, there are a good deal of expectations priced into the stock today. 

If the company is able to grow earnings at 25% annually for the next five years and trades at a P/E of 45 in 2019, here is what we are looking at in terms of investment returns: 

.75*(1.25^5)*45 = $103.00 

This is just under a double in five years from today's price of $53.06. Still, these are ambitious growth projections. Management is projecting operating income to grow 23%-24% in 2014, so I am not so sure we can confidently expect net income to grow at an average pace of 25% annually for the next five years. (Keep in mind that earnings grew 24% annually over the past five years. As the company grows larger, it will be increasingly challenging to continue growing earnings at this pace.) 

Another concern I have is the fact that Under Armour's cash flow production has been irregular over the past four years. The company produced -$115.86 million of free cash flow in 2013, pushing the company to issue stock and debt to finance a significant increase in capital expenditures (as well as a 39.89% decrease in operating cash flow production). There may be reasons why the company's cash flow production has been up and down over the past several years, but it isn't exactly something for which I am willing to pay a significant premium. 

As I've shown with SolarCity, I don't necessarily mind investing in a business who is still producing negative free cash flow, provided a) there is a great leadership team focused on long-term growth, b) the company is continually improving cash flow production over time (growing operating cash flow faster than capital expenditures), c) there are clear prospects for continued growth. 

In Under Armour's case, I think Kevin Plank is a great leader heading up an innovative business. However, I don't see the growth prospects or sound cash flow performance to back up such a lofty valuation in the present day. If the P/E drifted closer to 40 (or a price of $30 given the current EPS of $0.75), I would seriously consider opening a position in Under Armour. 

I am trying to build more discipline in my investing decisions, and part of this process is recognizing that bargains aren't readily available in today's market. I think there are still some great long-term investment opportunities available today, but I am not sure Under Armour should be at the top of the list. I am watching the company closely and want to do additional research, but these are my thoughts at this point. 

What do you think about Under Armour? 

David K

2 Comments – Post Your Own

#1) On April 21, 2014 at 3:15 PM, Almondfishing (< 20) wrote:

I have only become aware of UA through SA. But I have started seeing the label in sport stores - not as popular as Nike, Addidas, etc. I play sports, but not as much as some of my friends and family, but they had not heard about UA in Europe and South Africal. 

That said, It seems that they have much room to grow - even if they simply become a more common name, it would lead to greater sales.

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#2) On April 22, 2014 at 12:32 PM, gr8twhtebuffalo (51.39) wrote:

Nice review Pencil. I've been watching UA for some time now. I'm considering adding both UA and Nike to my portfolio.

As a brand I use Under Armour all the time. I work out a lot and wear both their dri-fit shirts and wear the running shoes.

UA is everywhere and the apparel they produce is top notch. I love to wear their clothes but in the end they're main competitor is a little company called Nike and the PE is too high. I'd like to see it under $45 and then I may consider a small position.

Have a nice day.

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