The Real Reason Under Armour Is Falling

Source: Under Armour.

Under Armour (NYSE: UA  ) was falling by more than 7.5% on Thursday after reporting earnings for the first quarter of 2014. The numbers were actually better than expected, and the company is clearly outgrowing competitors such as Nike (NYSE: NKE  ) and lululemon athletica (NASDAQ: LULU  ) by a considerable margin. What's the reason for the decline? Perhaps more important: What should investors do about it?

Running at full speed
Revenues during the first quarter of 2014 increased by an impressive 36% year over year, to $642 million versus $472 million in the first quarter of 2013. This was above Wall Street estimates of $599 million on average for the period.

Sales were strong across the board: Apparel sales increased 33% to $459 million; footwear revenues grew 41% to $114 million; and accessories sales jumped 43% to $52 million.

The direct-to-consumer segment represented a big 26% of total sales during the period, and it delivered an increase of 33% versus the prior year. International sales are still relatively small at 9% of sales, but firing on all cylinders with a whopping increase of 79% year over year.

While many other companies in the apparel business are implementing big discounts to sustain sales volumes, Under Armour remains remarkably strong on the pricing front: Gross margin increased to 46.9% compared with 45.9% in the prior year's quarter.

The combination of rapidly growing sales and expanding profit margins produced a big increase of 71% in diluted earnings per share, to $0.06 during the quarter. The number was comfortably better than the $0.04 per share forecast on average by Wall Street analysts.

Management sounded quite pleased with Under Armour's performance during the quarter, and the company raised its guidance for both sales and operating income during 2014.

Beating the competition
The level of performance Under Armour is delivering is not only quite impressive on a stand-alone basis, but also materially better than the growth rates generated by competitors such as Nike and Lululemon.

Nike is a rock-solid industry leader with tremendous scale and marketing power; however, it's hard for a company of Nike's size to grow as quickly as Under Armour. During the quarter ended on Feb. 28, Nike reported an increase of 13% in revenues to $7 billion, while future orders were up by 12% versus the prior year.

This is quite a strong performance for a company that is 10 times bigger than Under Armour in terms of sales; however, Nike is still no match for Under Armour when it comes to growth.

Lululemon is in a very different situation. The company is trying to recover its image from quality problems and public-relations scandals. Even if things seem to be clearly improving lately, Lululemon is still behind both Nike and Under Armour when it comes to recent growth rates.

Lululemon reported an increase of 7% in sales during the quarter ended on Feb. 2, to $521 million, which was better than the $514.9 million forecast on average by Wall Street analysts, and an improvement versus previous quarters. On the other hand, comparable-store sales decreased by 2% on a constant-dollar basis during the period.

A victim of its own success
Under Armour is arguably the most explosive growth story in the sports-apparel industry during the last several years. The company has generated formidable growth rates over time, and both analysts and investors seem to be getting used to outstanding financial performance.

When comparing valuation ratios for Under Armour versus peers such as Nike and lululemon, the company trades at a considerable premium. Under Armour carries a forward P/E ratio of nearly 45 times earnings estimates for 2015, versus 22 for Nike and 21 for Lululemon.

Under Armour most certainly deserves a premium valuation due to its extraordinary performance, but the reaction to the earnings announcement may be indicating that some investors probably got ahead of themselves when it comes to expectations.

Performance was remarkably strong during the quarter, the company is clearly outgrowing the competition by a wide margin, and management raised guidance for the rest of the year. If some investors are feeling disappointed, this seems to be related to excessive expectations as opposed to insufficient performance.

Bottom line
Under Armour is firing on all cylinders, outperforming the competition, and generating growth rates that are truly exceptional for a company in its industry. The recent decline seems to be related to excessive expectations prior to the earnings report, and not to a shortfall in performance. If anything, the dip in Under Armour could present a buying opportunity for investors.

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