UA beats consensus expectations, but we think our thesis is still intact.
Under Armour (UA) reported second-quarter earnings Tuesday morning, with results topping consensus top-line and earnings per share estimates. Revenue grew by 42% and diluted EPS by 73%. However, the $0.12 per share earnings number only beat our estimate by two cents, and the company was cash flow negative. We still think Under Armour should be trading at around $50, and see no reason to raise our fair value estimate. We make our DCF valuation model template available here, which can be used to value any operating firm.
Gross margins fall
As we predicted, gross margins fell by 250 basis points, which was even worse than we expected. The company also guided down for the full year gross margins by 160-180 basis points. On the conference call, management blamed input cost headwinds and an unfavorable product mix. We would like to point out that selling shoes and switching accessories from a licensing business to an in-house business is not an unfavorable mix, but rather a change in business strategy. We don’t expect to ever see margins in excess of 50% again.
CEO Kevin Plank also mentioned that the company is displeased with operational and sourcing costs. We’re glad Plank acknowledged the supply chain weakness, and we think the company will work hard to implement changes to lower costs.
Inventory growth of 74% in Q2
As we warned earlier, Under Armour experienced huge inventory growth of 74% in its second quarter. We think inventory growth of around 40-50% is much more reasonable, and that eventually Under Armour is going to take a haircut on some of this unmoved product. We wouldn’t be surprised to see a lot more sales and pricing incentives this quarter, which would lower average selling points.
Shoes disappoint again
We considered ourselves bearish on footwear in the first place, forecasting 40% growth in the quarter. However, footwear grew by only 31% in the second quarter. As we mentioned in a previous note, we don’t think the Under Armour brand has resonated with footwear consumers just yet, though we think the recent full-blown roll-out of micro g technology in running and training will best test our hypothesis.
Though the company has signed two NBA first-round draft picks since our last research (Kemba Walker and Derrick Williams), our recent checks suggest that basketball gear continues to collect dust in the discount section of Dick’s Sporting Goods (DKS) and The Sports Authority.
Some positives to take away
Plank spoke a lot about charged cotton on the call, which we consider a great product technically, and it appears to be making traction with male consumers, though he feels the launch hasn’t resonated as well with women. We’re also excited to try Storm Cotton, Under Armour’s new line of waterproof sweatshirts, which could be another high margin product to add to the UA repertoire, though we do not expect it to materially impact revenue growth or profitability. Overall, we continue to believe Under Armour is significantly overvalued, and still think put options remain one of our best ideas.