Under Armour, Inc. (UA)

JMB21 (< 20) Submitted: 7/1/2008 9:43:26 PM : Start Price: $26.54 UA Score: -0.57

UA was an issue that I made some money with in 2007. I sold when it looked like it was rolling over from a technical standpoint. At this point, it has rolled so far over that it looks like a good pick up from a value standpoint.
UA has strong fundamentals. It's consistent ROIC of over 15% rivals Nike's, and is very impressive for a younger company. Such a high ROIC is indicative of a competitive advantage, which I think comes down to Under Armour's brand and a product that consumers perceive to be superior. Sales and earnings growth has been remarkable, as has growth in shareholder equity, one of my favorite marks of an outstanding company. UA has grown cash flow at remarkable rates as well, although its high capital expenditures (appropriate for a young company plowing money into expansion, branding, and product development) have eliminated its free cash flow.

This lack of free cash flow for acceptable reasons is why I used a projected earnings model to value UA. If UA can grow earnings in line with analysts' expecations (25%), its p/e can come down to a very reasonable 21, and the stock would still be trading at nearly a 50% margin of safety, given a 15% discount rate. In other words, at a 15% discount rate, UA's current share price bakes in an earnings growth rate of 15%. If UA falls short of analysts' estimates by 40%, it will still meet that. So I figure the shares are a gogod buy right now.

There are, however, some significant risks associated with UA. First, as a company whose revenues are closely tied with discretionary consumer spending, UA would be expected to be quite sensitive to the economy, which is not a plus at this moment. Second, as a newcomer in a field with some heavy-hitting brands, UA's success may simply not continue as expected. Third, UA's newness and its heavy capital expenditures may make it difficult for the firm to weather some of the economic challenges that are believed to be coming down the pipe. UA doesn't have strong free cash flow to lean on, so if it wants to continue creating shareholder value in a stagnating revenue environment, it will have to cut down on capex, which will destroy its growth model.

Given UA's strong fundamentals, I think the significant margin of safety provided by its current price acceptably accounts for the risks associated with this relatively new business.