It's earnings season on Wall Street, and just yesterday, Under Armour (UA 1.73%) reported a blockbuster quarter featuring 22% revenue growth -- and 28% growth in profits. So naturally, Wall Street...downgraded Under Armour stock.
Yes, you read that right. But just as we saw with Visa's downgrade yesterday, Wall Street isn't acting quite as irrationally as it sounds. Under Armour may have beat estimates for fiscal Q3, earning $0.29 per share where analysts had expected to see only $0.25. But analysts are skipping past that fact, and focusing instead on the company's guidance for future earnings.
They don't like what they see. Here are three reasons why not.
Under Armour is lacing up for a long race. Wall Street just wishes it could run a bit faster. Image source: Getty Images.
1. The numbers
Under Armour grew its earnings 28% on 22% better revenue last quarter, which suggests strong (and strengthening) profit margins at the stock. Regardless, as fellow Fool Jason Hall pointed out yesterday, 22% revenue growth was "the slowest rate of growth the company has delivered in six years."
2. Slow and slower
The news gets worse. While Under Armour management insists it will end this year with 24% growth in revenue for the full year, operating income will grow only 8% to 9%. Looking out to 2018, management is sticking with its promise to pull in $7.5 billion in annual revenue, but no longer believes it will earn its hoped-for $800 million in operating profit.
Indeed, TheFly.com reports that profits will only grow in the "mid-teens" over the next couple of years -- about half the rate of profit growth we saw in Q3.
3. What went wrong?
This abrupt slowdown in profit growth has Wall Street worried. This morning, analysts at Cowen announced they are removing their outperform rating on Under Armour stock, and downgrading the stock to market perform. (Analysts at Stifel Nicolaus and William Blair are doing the same.)
Why all the pessimism? As reported on StreetInsider.com, Cowen believes there's a "structural change" at work in Under Armour's business model, where "retail partners, in a slowing N. American market, are managing leaner inventory profiles." This bottleneck in the supply chain is preventing Under Armour from "selling in" as much product as it would like to sell, as quickly as it would like to sell it. At the same time, at the retail level, consumers are demanding "faster flows" of new products, requiring constant tweaks to the products Under Armour offers, but preventing it from profiting fully from each new product as it comes out.
This, warns Cowen, implies that Under Armour will suffer "margin contraction into 2018" at least, and possibly longer than that.
What it means for investors
According to Cowen, this all results in "a more competitive industry and lack of margin expansion" hobbling Under Armour's business, and necessitates "a multiyear cut" in earnings expectations for Under Armour stock. Whether you focus on earnings per share, return on invested capital, or free cash flow (S&P Global Market Intelligence shows no FCF generated since 2014), the analyst simply doesn't believe that Under Armour can earn enough to produce "meaningful upside" to the stock's current price through 2020.
Translation: Under Armour stock could be dead money for years.
