Under Armour Doubles Down on Innovation With Its “Factory of the Future"

Under Armour (UAA 1.03%) recently unveiled their Lighthouse project, headquartered in Baltimore.

In this episode of Industry Focus: Consumer Goods, Vincent Shen talks with Seth McNew, who got to attend the event and tour the new facility. Listen in to hear some of the most exciting highlights from what he saw firsthand. Also, find out what Under Armour is promising will come of this venture; how this project ties into Under Armour's vision for the company; how Under Armour could still be a fantastic opportunity for long-term investors, even at the whopping 77 price-to-earnings ratio the company is trading at today; and more.

A transcript follows the video.

This podcast was recorded on Jul. 12, 2016.

Vincent Shen: Hey, Fools! Welcome to another episode of Industry Focus, the podcast that dives into a different sector of the stock market each day. It is Tuesday, July 12th, and I am your host Vincent Shen. Joining me from Colorado via Skype is Mr. Seth McNew. How's it going, Seth? Hope all is well.

Seth McNew: Hey Vince! It's going great, thanks for having me back.

Shen: Yeah, man! For our listeners, as you may recall, I hosted Seth in person here in Fool headquarters for the June 28th episode when we talked about Las Vegas. He was able to share some of his thoughts on Sin City after spending several months living there earlier this year. Once again, I'm tapping Seth to share his first-hand experience with us, this time to talk about everyone's favorite upstart sports apparel company, Under Armour. Under Armour has a lot of fans here at The Motley Fool. Its success has often been attributed to its innovative nature, that applies to its products, its marketing, a lot of other key aspects of its business. And all that is, of course, under the leadership of its founder and CEO, Kevin Plank.

The latest innovation push is Under Armour Lighthouse. This is a 35,000 square foot facility located at Port Covington in South Baltimore right on the Patapsco River. So, it used to be a large garage for city buses, but the inside now resembles something more so taken from a sci-fi film. Under Armour itself has referred to the new facility as "the factory of the future." 

In this episode, Seth was actually able to attend the opening ceremony media event for Lighthouse, and to see the tour led by Kevin Plank himself. So I wanted to get some details from him about that, other pushes they're making with things like 3D printing, and then ultimately just take a look at their valuation and what the company's prospects could potentially be for investors looking forward.

Getting started, what did you think, Seth, about the event?

McNew: It was really incredible! It was about two weeks ago that I got to go to their headquarters. Their new headquarters -- what will be their new headquarters, Port Covington -- is a little bit further south in Baltimore than where their current headquarters is. So, we drive from their actual headquarters, and you get to this building and it looks pretty unassuming. It was a city garage before, it looks like any bus shop, it's just a big square building, and we pull up, and outside of it, they have everything set up with seats and a DJ. Eventually, we all take our seats, and Kevin Plank comes up. Kevin Plank is so animated. He starts going off about why manufacturing in the U.S. needs to change, and what changing manufacturing can do for the apparel industry. He talks about other industries, like computers and cellphones, how far they've come, and he says that apparel manufacturing just hasn't changed much in the last 100 years. And you have some pretty interesting people attending this media event. You have senior White House policy advisors, some other government officials, you have pro athletes, and these other ones from the Ravens. 

So, he just starts talking about all these reasons why Under Armour is going to be the one to start innovating more than anybody else in manufacturing. And this is right outside of this square building. Then they open the doors, and we walk inside for the tour, which is given by Kevin Plank. It was like Willy Wonka and the Chocolate Factory for athletic apparel. It was really interesting. You get the sense that everybody there was just as excited as I was. You kind of just want to touch everything and see how everything is working. But, you're walking through the center, and it's all these engineers and designers that are wearing lab coats and fidgeting with half-built shoes. You felt like a kid from Willy Wonka and the Chocolate Factory. You're moving through, and they take you to each section. One section is 3D printing, then you get to another section and it's body scanning, and they have this athlete standing there and they're scanning his body, and you see the renters 3D images of his body on the screen, and how they can create clothes around that.

It was super fascinating. And the whole thing ... you're looking at all these products that are not to market yet. It was really fascinating.

Shen: Yeah, from the pictures that I saw, I thought it was really interesting. When you think of people in lab coats, I might think of people in the medical field or things along those lines, at a manufacturing facility. But in this case, for apparel, it's definitely a different take. Like you mentioned, very high tech. But, I remember the Lighthouse project seems to have a couple areas of focus around 3D design, body scanning, like you mentioned. Can you touch on those a little bit?

McNew: Yeah. They said there's four areas of focus that they're really working on here. The first one is 3D design and body scanning. That's related to how they're looking at how an athlete's body changes by season, what kind of fabrics are best for a moving athlete that's using the body scanning. The next one is 3D printing, which is both for actual product and for rapid prototyping. They have the massive 3D printers that are actually printing products that a consumer might use, and then to the lower end where they might create a product really quickly just to test out the size and shape. Then, there's another section that's for apparel and footwear prototyping in other ways, like with actual fabrics and some kind of molding processes. Then, the last one was apparel and footwear pilot lines. So, running manufacturing models to see if an idea or design would work at scale.

Shen: Can you give us a sense of some of the advantages that the company gets from this Lighthouse project? What are some perks or some innovative new products, or things they've been able to push out or test as a result of experiments like this?

McNew: They came out in March with these 3D printed shoes. They were the first company to make it to market with a 3D printed training shoe that was actually 3D printed. Some other companies have been working on it. New Balance came out with some in April. But these were the first ones out. I got to try a review pair. They were pretty interesting. They're a weightlifting shoe, and they have this 3D printed lattice heal. It's a design that you wouldn't be able to create without 3D printing. So, that was the first time that you really see this is a viable thing. I think a lot of people say 3D printing products, especially in apparel, is kind of a marketing gimmick. But I have to tell you, these shoes were incredible. And you can see how you would get more customization, better fit ... not everybody falls between a 10 and a 10 1/2 shoe size. So if you can get a 10 1/4 shoe size that fits perfectly to your feet, you can choose the customization of colors and the material. And then, of course, the biggest part of that is deliverability. With 3D printing, imagine if you can go to a store, and you can scan your foot and have a shoe made right then for you.

Shen: OK. I see here now, these were called the Architects. It seems like it was a pretty small launch, but the reception was pretty positive, and they sold pretty quickly, right?

McNew: Yeah. They only launched 96 pairs, which is a throwback to when they started in 1996. They sold them for $300 a piece, and they sold out in just 18 minutes online.

Shen: Oh, wow! Obviously not anything that's going to drive bottom line at the moment, but definitely proof of concept, would you say?

McNew: Yeah. It sounds like they're going to have another launch this summer. I'm not sure if it'll be a full launch, and they haven't released very much information about what that would look like. But definitely keep watching for that.

Shen: OK. Another big piece that you mentioned at the beginning was around local manufacturing, and that's a big push for why they created the Lighthouse facility. Could you touch on Plank's comments there during the media event, and what his thoughts are for how the business is focusing on that?

McNew: Yeah. Like I said, Kevin Plank is so animated. We're listening to him during this media event, and you get the idea that someday he might run for office or run for president. He's up there and he's shaking his fist and he says, "Jobs! Jobs! Jobs! That's what's really important right now!" He has this whole idea that through these kinds of manufacturing improvements, they're going to be able to bring, he said, tens of thousands of manufacturing jobs created in the U.S. Pretty much his idea is, by having a local for local, which means U.S. products made in the U.S., products for Brazilians made in Brazil, and local for local all around the world, you're going to be able to create these manufacturing hubs in different parts around the world where you're not shipping product halfway across the globe to get to a consumer.

Shen: OK, that makes a lot of sense to me. I can definitely see the appeal of making products more local. Again, this has kind of already gained some traction in other sectors, like the restaurant industry, even, if you think about some chains, and the fact that they've been able to market and be successful with the idea of sourcing a lot of their ingredients locally. Even, I look at the presidential election, quite a few candidates, you mentioned how Plank is almost like, giving a campaign speech. But a lot of the candidates have campaigned on the promise to strengthen and reinvest in manufacturing within the U.S. 

But I couldn't really find any specific numbers for the cost of the Lighthouse project and how much they spent on it, but I can understand if some investors and listeners might be a little concerned about this expansion, at least what the return on investment will ultimately be. So, how do you think the company is looking at this in terms of the return on investment, and how they're justifying the R&D there?

McNew: Right, I don't think they're breaking down their numbers on how much this costs. It's pretty much an investment for them as well. But, this is, I'm certain, a huge upfront cost. They said that some of these 3D printers could be over $100,000. You have some of the low end ones, and you have a few of these ones that are massive. But when you think about the long-term gains, not only from decreased manufacturing and transportation costs, but truly better and more innovative gear ...

He talked about how right now, a shoe being made in Asia could have hundreds of people touching a single shoe. So you have, imagine, a shoe model that's going down the factory line, and each person adds one little component to it. Whereas, he thinks that he can bring that down to just a couple people touching a shoe, and a lot less parts. So you have a lot less room for error, you have a much better product.

And then, think about the tax implications. Every government is going to be excited that there's going to be a manufacturing hub in their city or state. This is already happening in Baltimore. And like I said, there were senior White House policy advisors there. So, there's a lot of long-term gains to be made from this kind of push.

Shen: That makes a lot of sense to me in the sense that, we actually did an episode, I think it was one or two months ago, about inventory management. You mentioned how many people had to touch the shoe, for example, at an Asian manufacturing facility, hundreds of times to get the product done. With inventory management, people have commented on the idea that each transfer, from one party to another in the supply chain, is basically added cost and added time that prevents the product from hitting the market quickly. This seems like, and it's funny that this is more of a sports apparel company, but this seems like the ultimate in terms of fast fashion, in the idea that they can do these prototypes really quickly in Lighthouse facilities. And facilities like that might be able to give Under Armour the ability to create prototypes, like you said, reduce the time that's required to do that, and then get the market out, if the testing is successful or looks promising, to do that as quickly as possible.

McNew: Right. And, imagine that they're giving themselves a one to two-year lead on trying to make new product. You have to ship that product to the distributor six months in advance. So, it's summertime, and your shipping them winter gear, hoping that the audience still likes it in the winter. Whereas, if you can get something that's out in six weeks, you're going to be a lot more in time with what the market is looking for.

Shen: Absolutely. So, we had a chance so far to talk about some really cool opportunities, I think, for Under Armour that should really help drive its growth in the future. Shares of the company have traded up over 300% in the past five years. Its revenue has quadrupled over the same period to about $4 billion in 2015. And, based on the last earnings call, management now expects the company to hit the $5 billion milestone for 2016. Annual top line growth has been incredible. It's been in double digits for well over a decade. 

But, at the same time, I think you and I both know this stock is definitely not cheap. I believe you're an Under Armour investor. How do you think about its valuation? Are there any challenges you can see derailing its growth streak or its success streak?

McNew: Yeah, you're right. I am an Under Armour investor, and I'm kind of lucky that I jumped on the bandwagon pretty early. It's definitely not a cheap stock. It's gained about 15% just in the past few weeks, and that's pushed its price to earnings up to about 77X. Compare that to a company like Nike at 27X. But you know, there just doesn't look like there's a sign of slowing now. Even in the shorter term, they posted 20% quarterly year-over-year gains for the last 24 quarters, or six years. And the most recent quarter is 30%. It just doesn't look like there's a sign of slowing there. And then you think about these long-term investments, and think about how long-term investor you are. Are you looking for a short-term gain? Then Under Armour is probably not the stock for you. There's going to be too much volatility. If you're looking 10-20 years out, I think Under Armour is still a great play, even at this price.

Shen: Fair enough. Something I would like to add to that is just the idea that, if you look at some of their strongest growth areas, like their international segment, and that was just 11% of revenue in 2015. Their footwear growth has been off the charts, especially with some very well-chosen endorsement partnerships with Stephen Curry, for example. And footwear is still only 25% of revenue, and that was for the first quarter of this year. Again, showing phenomenal growth. I think the opportunities are definitely there, and you can see, again, the company has not forgotten how they got here in terms of that innovation with the original product, with the cold gear and the wicking materials, things like that. And they're still pushing in that regard, it seems.

McNew: Yeah, absolutely. I think, it's a smaller company than Nike. I think there's going to be some short-term risks. Look what happened with Sports Authority, how much the market hammered them for their write-off this year for Sports Authority going bankrupt.

Shen: Yes. Could you actually cover a little bit more about that, a little detail for our listeners? Obviously, Sports Authority is going to be a big retailer for Under Armour products. How much of an impact did that seem to make? It seems to me like you think it was maybe a little overstated.

McNew: Yeah, that one hits a little bit close to home. I'm a Coloradan, and Sports Authority is a local company. It started here in Colorado, and that's where their headquartered in. Sports Authority closing, I'm sure that's going to be a hit to them this year, and we're probably going to see that that takes a little bit of a hit in sales. But, I think it plays well into the story that what they're really looking for is direct-to-consumer growth anyways, which was massive. It was 30% growth in 2015 over 2014, to $1.2 billion, which is a huge part of their revenue. When you can get direct-to-consumer, that increases your profit margin, increases your control, especially when you're talking about how much you want local-for-local manufacturing. I just don't think that this Sports Authority closing is going to have as big of an impact in the next year or two years as the market thought it would be.

Shen: Fair enough. I agree, it's definitely much more of a short-term speed bump than anything else. But, what about longer-term? When you're looking at the stock as an investment, is there anything that concerns you of in terms of a bigger picture, a longer-term concern? For example, some people have mentioned the idea of Plank potentially leaving. That would be a huge hit. This is one of those companies that is very much driven by its founder. But at the same time, I see this being a relatively small risk, especially with the recent split and how he was able to maintain the founder control. Any other challenges or risks that you see that you think maybe our listeners and investors should consider?

McNew: Yeah. If Plank were to leave, I think that would be a huge risk. But you're right, he really just doubled down on the company recently by doing the split where he kept all control of the company. He's putting a huge investment into Baltimore itself with the new headquarters. He has a bunch of little side projects to build up the city to make sure that's a great place for Under Armour to be. I would say, one thing to look at is their debt level. Under Armour really started with not wanting to take on any debt. That was a big thing for Kevin Plank when he first started the company. So I just watch that. They have a lot of acquisitions, a lot of big investments, I would be hesitant if the debt started to get too high for such a small company. But I think right now, it's at really reasonable levels.

Shen: Fair enough. Going back to what you mentioned, I thought this was really interesting, with some of Plank's side projects. I know that next to Lighthouse, I think, there are a few other properties that he's involved with, or he owns, where it's like, they're supposed to be like think tanks or areas to encourage entrepreneurship and innovation. It seems like that whole Port Covington area is being built up as just a space for innovation in the city and investment in Baltimore.

McNew: Yeah, you could do a whole other show on everything Kevin Plank's doing in Baltimore outside of Under Armour. What you're talking about is actually right next to Lighthouse, in the same building, what they call Main Street and they have this whole area for entrepreneurs to come and have space and tools to work on their own products. But there's other things, like right on that Port Covington property, he's working on a whiskey distillery. He bought a farm with a horse racing track. He's a really interesting guy.

Shen: Wow. I might take you up on that. Maybe we can do an episode down the line to talk about some of the things that Plank is looking at. Just a really, I think, interesting leader in this industry, and obviously has led Under Armour to an incredible amount of success. Thanks a lot, Seth, for your thought. I think it's really cool that you were able to attend the Lighthouse event, for sharing that experience.

McNew: Absolutely. Thanks for having me again!

Shen: Cool. That's all from us today. You can share any questions or comments with us via Twitter @MFIndustryFocus, or shoot an email to [email protected]. You can also enjoy other great podcasts from The Motley Fool by checking out fool.com/podcasts. People on the program may own companies discussed in the show and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear on the program. Thanks for listening and Fool on!