Shares of Under Armour, one of the hottest growth stocks in the industry, have fallen 22% over the past 12 months due to concerns about its slowing sales, rising expenses, and tougher competition.
Yet shares of Adidas, a company that has often been overshadowed by Under Armour's growth and Nike's (NYSE:NKE) brand strength, soared over 120% during that same period. Surging sales growth during the first year of its five-year turnaround plan convinced many investors that the mistakes of its past -- most notably its money-draining acquisition of Reebok -- are now in the rear view mirror.
So is it time to sell Under Armour and buy Adidas? Let's compare the two companies' growth rates, valuations, and headwinds to find out.
How fast are Under Armour and Adidas growing?
Under Armour's sales rose 28% annually to $1 billion last quarter. While that figure looks healthy, it also represents a slowdown from 30% growth in the previous quarter and 29% growth in the prior year quarter. Analysts expect that slowdown to continue, with 21% growth in the third quarter, 22% growth in the fourth quarter, and 24% growth for the full year. That compares poorly to the company's 32% growth in 2014 and 28% growth in 2015.
25% of Under Armour's sales came from footwear during the first half of 2016, compared to just 20% in the first half of 2015. Apparel sales declined from 67% of revenues to 62% during that same period. This shift means that Under Armour is depending less on its "high tech" apparel and more on traditional footwear -- a tough market dominated by entrenched players like Nike and Adidas.
As a result, Under Armour started selling its shoes at lower prices. Back in March, Morgan Stanley reported that Under Armour shoes were selling for 23% less than two years earlier, versus an average 4% price decline across the industry. Nonetheless, Under Armour's footwear revenue rose 58% during the quarter, thanks to strong sales of its basketball shoes.
Adidas' sales rose 21% annually on a constant currency basis to €4.4 billion ($4.9 billion) last quarter, thanks to 30% growth in China, 26% growth in Western Europe, and 31% growth in North America. In the previous quarter, Adidas' sales rose 22% on a constant currency basis and just 9% in the prior year quarter. The company forecasts constant currency sales growth in the "high teens" for the full year, compared to 10% growth in 2015. It also expects to post double-digit sales growth across all markets except the Russia/CIS region.
53% of Adidas' sales came from footwear during the first half of 2016, compared to 51% a year earlier. The company attributed the category's 27% constant currency sales growth to robust demand for running shoes being partially offset by softer demand for basketball shoes.
Margins and profit growth
A major concern about Under Armour is that its increasing dependence on cheaper footwear is eroding its margins and earnings. That's why its gross margin fell 70 basis points annually to 47.7% last quarter. Meanwhile, Adidas' gross margin increased 50 basis points annually to 48.8% last quarter.
Since Adidas has a much larger retail footprint than Under Armour, the under dog needs to spend more heavily to remain competitive. Under Armour's aggressive spending on high profile endorsements, marketing pushes, and a big impairment charge from the Sports Authority bankruptcy caused its selling, general, and administrative expenses to soar 32% annually. As a result, its operating margin fell from 4.1% in the prior year quarter to just 1.9%. By comparison, Adidas' operating margin rose from 6% to 9.4% between the second quarters of 2015 and 2016.
Analysts expect Under Armour's earnings to grow 32% next year, which looks solid but doesn't fully justify its forward price-earnings of 50. Adidas' earnings are expected to rise just 9% next year, but the stock trades at a more reasonable 19 times forward earnings.
The winner: Adidas
Under Armour's headline numbers look stronger, but its growth is decelerating, its margins are contracting, and its valuations look lofty. Meanwhile, Adidas is posting rising sales growth and expanding margins, and its valuations look cheaper relative to its growth potential. Therefore, I believe that Adidas is the better buy until Under Armour posts stronger top and bottom line growth.