Factors Underlying Our $74 Valuation Of Under Armour (Part 1)

Baltimore based Under Armour (NYSE:UA) has been one of the best apparel stocks to invest in over the last couple of years. Its stock has risen more than 150% over the last year and as its outstanding sales over the holiday season show, it is not showing any signs of slow down in momentum. ^[1]. The company’s net revenues for the fourth quarter increased 35% on a year-on-year basis. Annual revenues for the fiscal year 2013 increased by 27% to $2.33 billion, exceeding expectations. The company also bagged the biggest professional deal with a college football team when it concluded the sponsorship agreement with Notre Dame college. Under Armour beat out bids from Adidas (XETRA: ADS) and Nike (NYSE:NKE) to secure the Notre Dame program. The deal gives them access to one of the largest fan bases and most valuable college football programs. ^[2]

Despite all these factors, our current price estimate for Under Armour represents a 35% downside to the market price. Our analysis below explains our bearish stance on the stock.

See our full analysis for Under Armour

High Apparel Growth Not Enough To Justify Growth Expectations

According to our analysis, the performance apparel division contributes roughly 70% to Under Armour’s stock. The annual revenues for this division in fiscal 2013 were $1.7 billion. We expect revenues for this division to increase to $4 billion by  the end of our forecast period. This implies a compounded annual growth rate of ~13% over the period. According to our analysis, the global sports apparel market is expected to grow at a rate of 4% to reach $178 billion by 2019. It is easy to see that we expect Under Armour’s apparel division to outpace the industry wide growth significantly for this period. However, even such an optimistic projection does not justify the market price in our opinion.

Additionally, if the company manages to achieve this growth, it will run into a common economic problem. Given time, competition will erode any competitive advantages enjoyed by a firm. This effect occurs because once a firm establishes competitive advantages, its superior operations generate boosted profits for itself, thus providing a strong incentive for competing firms to duplicate the methods of the leading firm or find even better operating methods. Moreover, the more profitable an industry, the more firms enter the industry, thereby reducing the premium available in the industry. Whether Under Armour manages to survive the consolidation and attrition process remains to be seen.

If we look only at the U.S. market, from which Under Armour derives 94% of the revenues, the company’s market share in the sports apparel market has grown from 12.7% to 14.7% making it the second biggest share holder behind Nike (~27% market share). ^[3] If Under Armour continues its strong growth in this region, it will soon start stepping on Nike’s shoes. 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 is considerably greater than that for 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 off investors. Under Armour will need to differentiate its products as being better. It remains to be seen whether Under Armour can retain its growth and increase its market share without putting excess pressure on its margins.

Women’s apparel market unexplored

According to our estimates, the global sports apparel market is expected to grow at a CAGR of 4% to increase to $178 billion by 2019. One factor that we attributed this growth to was the growing popularity of sportswear for women. Under Armour’s CEO Kevin Plank said the company was bullish on its women’s sportswear products as women are increasingly wearing athletic products outside of the gym. However, the company only has a 1.14% market share in the women’s sports footwear market, 11% share in the apparel segment and 19% share in the yoga-bottoms segment. ^[4] The company has stated the long term goal of increasing the revenues derived from its women’s business to exceed the revenues derived from the men’s business. Currently, women’s assortments contribute around 30% to the company’s overall sales. The company will have to incur significant expenses in order to grow these revenues in R&D, infrastructure and marketing. Moreover, the company has a masculine brand image at this point and changing that brand image can impact its men’s and youth businesses.

1. Holiday Season Cheer Under Armour [↩]
2. Notre Dame Under Armour Deal [↩]
3. Under Armour Still Has A Long Way To Go To Catch Up To Nike, Market Watch, October 2013 [↩]
4. Shrinking Pinking Under Armour, Ad Age, September 2012 [↩]