Factors Underlying our $74 Valuation of Under Armour (Part 2)

In our previous article, we outlined some factors supporting our $74 valuation of Under Armour (NYSE:UA). These can briefly be summarized as follows:

• We project the company’s most valuable division, performance apparel, to grow at ~13% til the end of our forecast period. This is higher than 3 times the expected industry wide growth in the same period. However, even such an optimistic projection is not sufficient to justify the current market price
• We believe that a significant portion of this growth is going to come from the growth in the women’s sports apparel segment. Under Armour does not have a strong enough position to capitalize on this growth opportunity. More broadly, Under Armour’s plans to grow its women business to become an equal contributor to its men’s business require significant investments in marketing, R&D and store infrastructure. These expenditures should put some pressure on the company’s margins.

In this article, we cite some other factors corroborating our stance, which implies a 35% downside on the stock.

See our full analysis for Under Armour

Meaningful International Growth Cannot Be Expected Soon

In the fiscal year 2013, Under Armour attained 5.9% of its revenue from outside the U.S. The company has made  investments to support its international expansion plans. Under Armour opened an experience store in Shanghai, China. The main objective of the shop is to introduce Chinese customers to the Under Armour brand through a video featuring athletes’ training experience. Under Armour has more offices outside the U.S. than within, and it is targeting Brazil and the Middle East to attain major growth over the next two years. However, despite these efforts international revenues have remained flat. In fiscal 2012, Under Armour generate 6% of its revenues internationally.

The main obstacles to international growth for Under Armour can be summarized as follows:

• In the U.S., over 70% of Under Armour’s sales come from sporting goods retailers such as the Dick’s Sporting Goods, Sports Authority, and Foot Locker. The absence of these distribution channels is impeding growth overseas.
• In areas where such distribution channels are available, the deals aren’t optimum. Under Armour licenses Dome Corporation to sell its products in Japan, but this deal requires the company to give away a significant portion of its profits. Even after 10 years of operation in Japan, licensing revenues from the region only contribute less than 3% to the company’s top line. ^[1]
• Under Armour relies on endorsements from well recognized stars for its marketing campaigns in the U.S.. The company has been able to rope in several big names to sponsor its products in the region. However, the same is not true of Europe or Asia. In Europe, Under Armour has sponsorship agreements with English football club Tottenham Hostpur and the Wales national rugby team. Both of these are lucrative deals but they do not provide the company access to large fan bases. For comparison, Nike and Adidas have sponsorship agreements with football clubs such as Manchester United, FC Barcelona, Real Madrid and Chelsea FC respectively. These sports teams are some of the biggest sports franchises in the world. Under Armour still has a long way to go to catch up with competition in this area.

Footwear Still Too Small

The market share of Under Armour in the U.S. footwear market has grown from 1.68% to 2.25%. Introducing more granularity into the numbers, we can see that the company has been able to grab 2.7% and 2.1% of the running shoes and footwear markets respectively. The footwear market is a highly segmented space and Under Armour can leverage the brand loyalty it has generated from its performance apparel customers to increase its share in these markets. It aims to grow its revenues in the footwear division from $290 million currently to ~$600 million by 2016.

However, there are some caveats here for the company. Gross margins in footwear are 30% lower than in other categories. So far, the company has only been able to sell shoes at lower prices. Future plans to roll out shoes in medium and in high price ranges will therefore require careful brand positioning. Under Armour also aims to make inroads into the basketball shoes segment and has recruited several NBA stars to endorse its products. ^[2]

This in sharp contrast to the market leader in this segment, Nike. Nike has shown time and again that it possesses the ability the pass on higher input costs to the consumer. The company’s brand loyalty is such that customers are willing to pay high prices to purchase shoes styled around icons such as Michael Jordan, Kobe Bryant and Lebron James. Moreover, Nike’s footwear division is highly diverse. The company makes training shoes, running shoes, basketball shoes, football shoes, slippers, sandals and kid’s shoes. Under Armour has next to no presence in most of these categories.

See More at Trefis | View Interactive Institutional Research (Powered by Trefis)

1. Shop For Under Armour [↩]
2. Can Under Armour Compete With Nike’s Footwear, Baltimore Business Journal, October 2013 [↩]