Why the Shorts May Be Right About Under Armour

I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But even I have to admit some growth stories are bogus, hence this regular series.

Next up: Under Armour (NYSE: UA  ) . Is this activewear supplier the real thing? Let's get right to the numbers.

Foolish facts

Metric

Under Armour

CAPS rating (5 max) ****
Total ratings 2,771
Percent bulls 92.1%
Percent bears 7.9%
Bullish pitches 428 out of 477
Highest rated peers Weyco Group, LVMH Moet Hennessy, Delta Apparel

Data current as of Jan. 28.

Enthusiasm for Under Armour escapes me. I've never understood the company's competitive advantage. The clothes and shoes are great, sure, but materially better than alternatives? I don't see how; Fools think I'm not looking hard enough.

They may have a point. Last week, Under Armour easily bested Wall Street's average fourth-quarter earnings estimate. The company delivered $0.44 in profit, $0.07 a share more than analysts were calling for. Revenue soared 36%, and the stock shot up 11% on the news. This is what happens when bulls get emboldened.

"With a niche of sporting equipment that will never go out of style, unless kids, adults and the pros stop playing sports, their inventory will always have value, further strengthening their balance sheet. Under Armour is poised to take a sizable chunk of Nike's (NYSE: NKE  ) market share away," wrote Foolish All-Star brandongasper in October, months before Under Armour scored a huge marketing victory in college football's national championship game.

In that contest, Under Armour outfitted winning Auburn, while Nike outfitted runner-up Oregon. Each brand scored tens of millions of dollars' worth of marketing airtime during the game, but it's Under Armour that recently inked a long-term deal with Auburn. Today, it looks like a winning arrangement.

The elements of growth

Metric

2010

2009

2008

Normalized net income growth 32.2% 17.9% (21.5%)
Revenue growth 24.2% 18.1% 19.6%
Gross margin 49.9% 48.2% 48.9%
Receivables growth 28.6% (2.4%) (13.1%)
Shares outstanding (in millions) 51.1 50.2 49.3

Source: Capital IQ, a division of Standard & Poor's.

And that's not all investors have to cheer about. Under Armour has spent years putting up mostly good numbers. Let's review:

  • Accelerating revenue growth combined with rising gross margins suggests two things. First, demand is rising. Second, Under Armour is seeing pricing power in its core business.
  • Normalized net income is rising even faster. A 2008 reversed into a big 2010 gain. Growth investors like me love to see this sort of trend. When combined with accelerating revenue, it tends to reflect leverage in the business expressed as high returns on capital and even higher cash flows.
  • Yet that's not what we have here. A sharp rise in receivables and inventories has stunted free cash flow over the past 12 months. On an absolute basis, FCF fell 80% last year. This makes sense if Under Armour is gearing up for massive growth. Otherwise ... uh oh.

Competitor and peer checkup

Company

Normalized Net Income Growth (3 yrs.)

Hanesbrands (NYSE: HBI  ) (0.9%)
lululemon athletica (Nasdaq: LULU  ) 57%
Nike 5.1%
Under Armour 6.9%

Source: Capital IQ, a division of Standard & Poor's. Data current as of Jan. 28.

Interestingly, it's another Rule Breakers pick -- lululemon athletica -- that gets the nod in this table. Fools aren't as enthusiastic, but I think they're wrong. Unlike Under Armour, lululemon has a history of keeping a tight rein on inventory and receivables. Cash flow has ballooned as a result.

Grade: Unsustainable
I've never before sided with one rebel stock over another in one of these columns, so I guess you can call this a first. Lululemon enters my CAPS portfolio on the long side, as I join my Foolish colleague Rich Smith on the short side on Under Armour. Unexplained inventory bugaboos simply create too much risk at current prices.

Now it's your turn to weigh in. Do you like Under Armour right now? Let us know what you think using the comments box below. You can also ask me to evaluate a favorite growth story by sending me an email, or replying to me on Twitter.

Interested in more info on the stocks mentioned in this story? Add Hanesbrands, lululemon athletica, Nike or Under Armour to your watchlist.

Lululemon and Under Armour are Motley Fool Rule Breakers recommendations. Under Armour is also a Motley Fool Hidden Gems pick. Nike is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool owns shares of Lululemon and Under Armour and is also on Twitter as @TheMotleyFool. Its disclosure policy thinks Monty Python is sustainably funny.


Read/Post Comments (7) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 31, 2011, at 8:11 PM, Pirastra wrote:

    I don't think shoppers see much difference in UA and NKE. That bothers me more than inventory. There is a big difference in LULU, and that's good, but LULU's customer service and return policy are downright ugly. For each of the three, there are reasons to buy, reasons to sell and reasons to hide and watch.

    I'm long UA and LULU, but I'm on the wire.

  • Report this Comment On February 01, 2011, at 8:18 AM, dmarksb wrote:

    I had the opportunity to meet Kevin Plank and his team at their headquarters several years ago. The youth and enthusiasm is unprecedented. The confidence and loyalty to their product and company goals stand out in my memory. I have had similar onsite opportunities with Nike and always come away covered with "corporate dust" where the bottom line is the main focus of the real people working at the "swoosh"! Finally, just wearing UA merchandise makes me feel good and I am proud to be a stockholder. I know none of these factors will have much weight with you and the other talking heads in the investment world but to us UA devotees - and it is amazing how many UA logos I see every day - it is an intangible plus for Kevin and his team. We just love it when you guys try to dilute the success story and certainly enjoy watching our portfolio values soar.

  • Report this Comment On February 01, 2011, at 9:07 AM, DaveGruska wrote:

    I got in UA in the mid-30's (when their P/E was also in the 30's), and am happy holding here, though I'm not adding any more shares at this level. The cash flow/inventory issue does bother me, and I didn't like Plank's answer that inventory is difficult to figure out.

    I'm reading a lot of stories about how UA is overpriced now because of this, and I admit it's a concern. But I think people are underestimating UA's shoe comeback, as well as the potential of their upcoming "Charged Cotton" product. I'll give them a few more quarters at least to get their inventory "figured out".

  • Report this Comment On February 01, 2011, at 12:41 PM, JohnEHibbert wrote:

    Does anyone have more information on how UA accounts for the A/R and why they have risen so much?

    Does the rise simply mean that they are sending more merchandise out to stores and as a result the receivables from those stores are simply rising?

    ....Or does it mean that existing merchandise in stores is simply not selling and as a result those receivable balance are simply staying put/rising with each delivery?

  • Report this Comment On February 01, 2011, at 1:38 PM, Fam62c wrote:

    I think that you are missing the point in a big way. Never underestimate the value of a premium brand name. Coke isn't inherently better than RC cola or Sam's Choice cola but the name is what generates the sales and the price premium. UA has done an incredible job establishing and promoting a brand in a very competitive industry. The sportswear market is huge and UA is still a small (tiny compared to Nike) company. Who knows what will happen in the future but I see UA as a well managed, leading edge company with a history of success and a solid balance sheet. With a well established brand name and new product lines/markets I think UA has has a lot of room to run going forward.

    People are shorting UA simply because it has come up in price quickly and has a high PE but you have to look at more than that. People keep saying that UA is way over-valued but look at the growth rate and the potential of the new product lines like cottons and shoes as well as the potential for significant global sales increases. Personally I think that shorting strong, growing companies with solid balance sheets in a bull market is a fool's errand. There are a lot better short bets out there than UA. Go back and look at Nike stock 25 years ago to get some idea of what's possible (but no sure thing) for UA.

    Nothing I can see now leads me to believe that UA's success won't continue for the forseeable future. Having an iconic brand name in a relevent industry with a long history of growth is an almost foolproof path to success. UA is well on it's way to being one of those brands. I predict that UA will get a few upgrades in the near future and many of the short sellers are going to have to duck and cover. UA stock is not cheap by any stretch of the imagination but the company growth is catching up to the share price at a rate that I believe will keep the price from falling very far unless the whole market corrects significantly.

  • Report this Comment On February 01, 2011, at 2:52 PM, cali23 wrote:

    I have three young boys and all they want is Under Armour. Under Armour everything -- shirts, shorts, sweats, socks, shoes, cleats, etc. It's all their friend wear too. They could care less about Nike. Under Armour has captured a generation of kids that will Nike will never get back. That's all I need to know. I'm long UA

  • Report this Comment On February 16, 2011, at 4:04 PM, WhiteHatBobby wrote:

    Long UA -- knew they were an up and coming brand when I took my shots many years ago. Having the football and baseball titles mean so much, and considering how the Southeastern Conference has the only network television deal that's national (not regional), both teams wearing UA was huge.

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