Major Risks That Could Lead Under Armour’s Growth To Stall

We believe that Under Armour (NYSE:UA) has a bright future ahead but there are some risks that we need to keep in mind as we evaluate the company’s potential. Investors should be especially prudent when investing in high growth companies as any hiccup in the company’s sales growth or outlook can cause the shares to come crashing down. Just ask Chipotle or Green Mountain investors.

First, given the discretionary nature of the products Under Armour sells, the state of the economy can have a meaningful impact on the company’s sales. If consumers are strained financially, they may pull back on discretionary spending which would directly impact Under Armour’s sales. Second, though the company has emerged as a forerunner in the performance apparel and footwear market, many larger competitors have caught wind of the potential in these markets and have introduced products that directly compete with Under Armour. The company’s long term potential will partly be determined by how well it can fend of this emerging competition. Lastly, apparel manufacturers have faced significant inflation in raw material prices in the past few years and have suffered declines in gross margins as a result. If inflation in cotton or oil picks up once again UA may once again see an impact to their gross margins. Below we highlight the key risks in more detail.

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Macro:

UA’s products are discretionary products and if the US sees an economic slowdown, or worse a recession, the company’s sales will be significantly impacted. However, given the company’s expansion of its retail store footprint and introduction of new products, the company has in its power the ability to offset some of the impact from the macro economy by growing stores or expanding to more product categories. Additionally, the company has minimal exposure to Europe and China, further insulating it from slowdowns in these strained markets.

Competition:

Competitors such as Nike and Adidas have taken note of Under Armour’s success with performance apparel and have introduced their own lines of apparel with similar moisture wicking fabric properties. So far they have not been able to significantly knock UA’s off its path of gaining share in the US, but if consumers shift brand preference to competitors or if competitors start offering products at a steeper discount, UA may start seeing some share erosion in the US.

Cost Pressures and Inventory Levels:

The primary contributors to raw material costs are cotton and oil, which is used to make some of the synthetic material used in the company’s products. If we see another spike in cotton prices or oil prices as we saw in 2011, the company’s margins will be pressured. Another issue the company faced last year was low inventory levels at retailers due to stronger than expected demand. If the company cannot fix its supply chain issues, it may incur charges from retailers for not providing adequate levels of inventory. Separately, the company is currently undergoing a SKU rationalization and expects to reduce its total number of SKUs by approximately 20% in 2012.