Obstacles To Under Armour’s Growth

Sports apparel company, Under Armour (NYSE:UA), recorded a strong 2013 as its stock rose by nearly 80%. The growth story continues as the stock hit a 52-week high of $88.03 on January 2. Despite this rally, the company is still exposed to many risks that investors should be mindful of. This is the first in a series of two articles that outline the potential risks faced by Under Armour.

In this article, we talk about some of the factors that the company will be exposed to over the long term.

See our full analysis for Under Armour

1) Intellectual Property Rights

Many of the specialty fabrics used in Under Armour’s products are technically advanced textile products developed by third parties. The fabric used to manufacture the products is sourced by manufacturers from suppliers pre-approved by the firm. ^[1] The technology and materials used by the company are not unique to it and it does not own any process or fabric patents. These are mainly held by their suppliers. The lifetime of a patent is only around 20 years, after which the technologies will enter the public domain, making it much cheaper to make imitative products. Moreover, larger competitors such as Nike have started producing products based on similar technologies (eg: DRI-FIT). These competitors can easily out-price and out-sell Under Armour’s products owing to their greater economies of scale. ^[2] A mitigating factor is that the company has applied for some patents of unique products and designs in the last two years and expects to file more in the future. Additionally, Under Armour owns several trademarks that can prove more useful for brand building and marketing, as trademarks last indefinitely compared to patents, which are time limited. ^[3]

2) Cotton Prices

The main raw material used in Under Armour’s product is cotton. As a result, its profit margins are extremely vulnerable to any movements in the price of cotton. One concern here is that cotton farming has been losing profitability. Cotton farming is a highly labor intensive activity and the wages paid to laborers working in cotton fields have to rise to keep up with the overall rise in price levels. Rises in labor costs cannot be passed on to the buyers as cotton prices are set through mechanisms extraneous to this process. If this trend continues in the future, cotton farmers might have to shift to other crops with more stable cash flows. This would reduce the supply of cotton in the market, thereby raising its prices. ^[4] Prices for cotton are up about 55% from a year earlier as farmers switch to other crops.(( Cotton Prices Rise ))

3) Oil Prices

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 oil picks up once again, Under Amour may see an impact to their gross margins again.

Under Armour’s products are exposed to oil prices in two ways: 1) Petroleum based products are used as raw materials in their manufacture; 2) inbound and outbound freight costs are incorporated into the prices of products. If crude prices rise, the management might not be able to pass on these costs to customers and this will impact their margins. ^[5]

4) Competition

Under Armour’s appeal has been its products that are difficult for others to imitate. This exclusivity comes from its unique fabric technology and brand name, and the fact that it has had to face very little competition in the niche performance apparel market, of which it is the market leader. The future growth potential from serving the same customers is limited, however. In order to continue this growth story, Under Armour will have to start serving new customers and expand into new sectors. The challenge for Under Armour will come when they start expanding and stepping on their larger competitors. In order to successfully ride this competition, the firm will have to start producing products that are either cheaper or better. The marginal cost of production for Under Armour should be considerably greater than that of Nike. Even if Under Armour sets its prices low, Nike can afford to set its prices lower as it can absorb those losses without warding of investors. Under Armour will need to differentiate its products as being better.

In the second part of the article, we’ll talk about some factors that investors should be cautious of in the near term.

our $74.20 price estimate for Under Armour represents a ~15% downside to the market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Who makes Under Armour’s Products? [↩]
2. Nike is loading up on patents [↩]
3. Under Armour new zipper technology [↩]
4. Cotton industry losing profitability [↩]
5. Under Armour 10Q [↩]