Is This a Red Flag for Under Armour?

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Can you trust the numbers that highflier Under Armour (NYSE: UA  ) is putting up? The stock has been on quite a run as it sits near all-time highs. Here's one reason you should take a deeper look.

The vast majority of companies use accrual accounting instead of cash accounting. Accrual accounting allows a company to book revenue independent of the cash movement related to the transaction. This allows more appropriate matching of revenues and expenses that don't rely on the timing of cash flows. For example, if a retailer sells a widget on credit, it will recognize the revenue from the sale and increase its accounts receivable prior to collecting cash.

A potential warning sign arises if a company begins using accruals aggressively to recognize revenue. If the company isn't able to collect cash for all its sales, accounts receivable will tend to start growing faster than revenue.

In order to see how heavily a company relies on accruals, you can calculate an accruals ratio based on either the balance sheet or cash flow statement. Using the balance sheet, you divide the change in net operating assets by the average net operating assets over a period. Net operating assets consist of the difference between operating assets (total assets less cash) and operating liabilities (total liabilities less total debt). I prefer to use full-year data since it gives a broader view of a company's financial position. A higher ratio implies lower quality earnings.


Accruals Ratio

Revenue Growth

A/R Growth

Under Armour 28.1% 24.2% 28.6%
lululemon athletica (Nasdaq: LULU  ) 5.9% 57.1% 10.7%
Nike (NYSE: NKE  ) 13.3% 9.7% 18.4%
The Gap (NYSE: GPS  ) 4.3% 3.3% 36.7%

Source: Annual reports, figures for most recent full fiscal year.

You can't pay bills with accounts receivable
A high accruals ratio combined with accounts receivables growth outpacing revenue growth is not sustainable in the long run. Eventually, you need cash to operate. If this trend were to continue or get worse, I would exercise extreme caution. It's also worth noting that Under Armour has been having a problem generating free cash flow. Not even having a strong brand image will help you unless you can back it up with dollars in the bank.

These facts alone won't tell you the whole picture, but they do warrant a closer look. Under Armour is putting up some impressive headline figures, but the numbers behind the headlines are what bother me. I wouldn't invest until these underlying issues are addressed once and for all.

Fool contributor Evan Niu owns shares of lululemon athletica. The Motley Fool owns shares of Gap, Under Armour, and lululemon athletica. Motley Fool newsletter services have recommended buying shares of Nike, Under Armour, and lululemon athletica. Motley Fool newsletter services have recommended creating a diagonal call position in Nike. Try any of our Foolish newsletter services free for 30 days. 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 has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (7)

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  • Report this Comment On July 26, 2011, at 8:00 AM, DaveGruska wrote:

    Good article - thanks. I'm trying to figure out this ratio from the current earnings, but I'm having trouble parsing your statement, "divide the change in net operating assets by the average net operating assets over a period".

    So far, I've got:

    Net operating assets as of 6/30/2011:


    Net operating assets as of 6/30/2010:


    Where do I go from here, or is this even the correct periods to compare?

    Thanks in advance.

  • Report this Comment On July 26, 2011, at 9:24 AM, TMFNewCow wrote:

    Thanks for reading. I calculated Net Operating Assets (NOA) for 6/30/11 as (766,189 Total Assets - 119,684 Cash) - (227,723 Total Liabilities - 36,857 Total Debt) = 455,639.

    Couple notes on that: when calculating total debt don't forget to add in the current maturities of long term debt, so total long term debt including current maturities is 31,290 + 5,567 = 36,857. Also, for analytical purposes I like to include capital lease obligations as debt. I've left it out here since this press release doesn't include that much detail whereas the full year 10-K conveniently discloses the total debt and capital lease obligations including current maturities.

    That being said, the same calculation for 6/30/10 gives me NOA of (570,099 - 156,089) - (146,984 - 15,580) = 282,606.

    To calculate the balance sheet accruals ratio, it would be the change in NOA, 455,639 - 282,606 = 173,033. The average NOA for both periods is (455,639 + 282,606) / 2 = 369,122.5

    Dividing out gives you 173,033 / 369,122.5 = 46.8%!

    To do a similar calculation but with cash flow statement figures, the numerator of the ratio is replaced with (Net Income - Cash Flow from Operations - Cash Flow from Investing). I come up with 30.1% for a cash flow statement accruals ratio.

    Hope that helps!


  • Report this Comment On July 26, 2011, at 10:59 AM, DaveGruska wrote:

    Thanks, Evan. I really appreciate the detailed response. I've started reading more about using accruals ratio, and it seems like an extremely useful metric.

    Pretty scary numbers with UA. Their Tide Point headquarters purchase is probably throwing things off a bit here, but there are obviously other problems as well.

    I caught part of the conference call this morning, and I don't get the feeling that they're trying to hide anything - it sounds like they know they have issues with this, and are taking steps to fix it (hiring a new director of planning, or something to that effect).

    I also read last month that they implemented SAP's BPC software to help them manage inventories. ( We use this software where I work, and if used well, it can give you a lot of planning insight.

    Hopefully things will improve for them.

  • Report this Comment On December 06, 2011, at 11:01 AM, rabec1 wrote:

    Hopefully UA will miss their numbers and the stock will drop so I can buy more. Great company, great products.

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