Under Armor (UA)

If you're not familiar with Under Armor you may not get out much... Or maybe you're just not into sports. The company has done an incredible job building its brand recognition. Its apparel products feature synthetic material that wicks sweat away from the body keeping the athlete's body temperature better regulated both in heat or cool temperatures. The brand name is developing a cultish following from both active athletic individuals as well as people who just want to wear the latest hip styles.

The company has been public for less than a year and the stock has done remarkably well. Of course it helps to have sales growth above 40% for each of the last 5 quarters and earnings that constantly come in above last year's levels. Management has set long-term expectations for revenue to grow 20% annually and earnings to expand 25%.

Marketing is an important part of any consumer driven business and UA spends plenty of talent and money in this area. Prize athletes have been signed to exclusively wear UA product and these endorsements are often quite pricey. The official guidance is that marketing should comprise 10-12% of revenue but Q2 is expected to exceed this level. The higher marketing is likely due to the new line of cleated footwear that will be touted for baseball season after finishing a relatively successful launch of its football cleats this past fall. Footwear has lower margins but management is excited about this new endeavor as it helps to ramp sales in a new area less correlated with their typical apparel sales. The company has announced that they will launch non-cleated footwear in 2008.

Nearly 80% of revenue is derived from wholesale channels as the company sells to established retail institutions who mark up the product for the end users. The Sports Authority and Dicks Sporting goods together comprise 37% of revenue. A disruption in either of these relationship would be extremely disruptive to UA. Expansion into Europe has begun with the opening of an office in Amsterdam, and the company believes there is ample opportunity to grow overseas.

While i fully respect the company, its growth, and it's products; there are a few issues that have me concerned. The first revolves around the apparel that the company has based its image off of. This fancy material is not patented and to my understanding, it is completely possible and probable that another competitor can make a product with all the same characteristics (without the trendy UA logo of course) and sell it at prices that compete directly with UA. Trends come and go, and UA cannot expect its popularity to remain forever without true product differentiation.

The second issue is the value of the stock. If the company beats expectations this year and earns $1.00 the stock is trading at a 48x multiple of forward earnings. If the company REALLY beats next years estimates and comes in at $1.50, the stock is still trading at over 30x 2008 earnings. Now it is foolish to short a stock just because of a high multiple, but some chinks are starting to show in the armor (pardon the pun - yes that was bad).

When the company announced earnings this quarter, the stock gapped down and traded lower for a full 2 weeks. This was after failing to break to a new high earlier in April. Since then the stock has traded up to just below the 50 day line and has seen resistance in this area twice. I believe at this point the odds are stacked against the stock and any bad news (and possibly good news that isn't good enough) will lead to a significant selloff. I would be cautious holding any long positions as the momentum appears to be broken and the stock definitely isn't at a point where value players are interested in taking a look.



UA notes