Why Under Armour's Pain Could Be Nike's Gain

One analyst worries Under Armour is losing apparel market share in North America. Is Nike the beneficiary? Credit: Under Armour,

Last week, Under Armour (UAA 0.74%) stock plunged as the market contemplated a downgrade and target price reduction from Morgan Stanley analyst Jay Sole.

Based on data from retail channel reporter SportScan, Sole expressed concerns that Under Armour is losing market share in its core apparel market for the first time in three years "and, more surprisingly, ASPs are falling at an accelerating pace." Sole went on to note both trends are particularly evident in women's apparel -- which Under Armour hopes to grow at least as large as it's men's business over the long term -- despite what he described as "major marketing investment" in the women's division last year. What's more, Sole expressed worries that Under Armour's running footwear prices had declined 20% since January, compared with a more modest 4% decline for the industry overall.

Finally, while admitting warm weather can serve to explain some of these trends, Sole believes Under Armour's bread-and-butter United States apparel market may be approaching maturity faster than expected. Considering international markets still only comprised around 11% of Under Armour's total sales (and that's after growing 52% year over year last quarter), let it suffice to say investors may not react well if Under Armour's stateside growth shows signs of waning.

That said, I've already suggested Sole's criticism may not be entirely merited. Under Armour management did, after all, warn last quarter that gross margin would decline in the near-term as it works to clear excess inventory and begin 2016 with a clean slate, particularly as it learns to cope with growth from its burgeoning footwear business, where revenue climbed 61.4% year over year last quarter. Meanwhile, Under Armour CEO Kevin Plank pointed out that much of his company's growth in women's to date has come with very little effort and resources behind it, so the company "now need[s] to be more aggressive" to continue taking share.

"It's certainly competitive"
But putting aside my doubts over whether investors should be truly concerned, let's assume Under Armour is indeed losing market share in Women's, and, more broadly, in its U.S. apparel business. Where would this lost market share end up?

More than likely given Under Armour's position as a premium brand, I think the bulk would go straight to Nike (NKE -0.36%).

To be sure, much in the same way it has done in recent years with footwear, Nike has enjoyed positive ASPs in apparel for the last several quarters thanks to its outsized focus on bringing greater innovation to the apparel market.

During Nike's most recent conference call last month, CEO Mark Parker had this to say:

The apparel market is definitely different than the footwear market. It's certainly competitive. We see the same opportunity to bring a premium performance position to apparel that we do in footwear, however, and that's our focus. We are actually accelerating our innovation efforts, and advanced R&D program. And some of our design for manufacturing efforts in apparel are really aimed at trying to elevate our performance position there. [...] And there is definitely a consumer appetite there.

Nike Brand president Trevor Edwards elaborated, "I will just add that what we also continued to do is we continue to attack segments within the apparel market by category that offer a more premium position." (Emphasis mine.)

And make no mistake: In the earliest years, that premium position in apparel was effectively created through high-tech innovations introduced on a regular basis by Under Armour. It was only natural, then, that its much larger competitor in Nike would continually ramp its own efforts to do the same.

The silver lining
That's not to say Under Armour can't successfully compete with Nike in apparel and sustain North American growth overall. But it's also worth noting that when Under Armour recently accelerated its long-term goal to achieve 25% compound annual revenue growth between 2014 and 2018, included in that goal was an assumption of more modest 21% annual growth from its largest business in North America. For perspective, last quarter Under Armour's North American revenue grew 25% to $1.06 billion. And while it doesn't specifically break down U.S. apparel within that number, global apparel sales climbed "just" 22.8% to $865.5 million.

Meanwhile, Nike's North American apparel segment grew just 8% over the same period to $1.22 billion. So given Nike's ramp to accelerate its own apparel growth, and assuming Under Armour's long-term CAGR goal of 21% in North America, investors shouldn't be surprised if UA's stateside growth continues to moderate over the next several years.

On top of that, Under Armour's 21% goal includes that of footwear, in which it is not alone in facing temporary gross margin headwinds. Keeping in mind footwear regularly represents more than 60% of Nike's North American revenue, CFO Andy Camption told investors during Nike's most recently quarterly conference call that gross margin in the coming quarter will fall by around 50 basis points, "reflecting our efforts to more expeditiously clear inventory in North America while bringing new innovative products to market."  Perhaps Under Armour's falling footwear ASPs aren't that concerning after all.

Nonetheless, investors would be wise to listen closely for early signs of a North American slowdown when Under Armour officially releases fourth-quarter results next week. While that shouldn't be terribly alarming for Under Armour right now, it could mean Nike is poised to demonstrate even greater strength.