Shares of Under Armour (NYSE:UA) (NYSE:UAA) plunged more than 20% on Oct. 31 after the athletic footwear and apparel maker posted a dismal third quarter earnings report. Its revenue fell 5% annually to $1.41 billion, missing estimates by $70 million and marking its first sales decline as a public company. The drop was led by a 12% sales decline in its largest market, North America, which wiped out its double-digit growth in overseas markets.
On the bottom line, Under Armour's net income plummeted 58% to $54 million, and its adjusted earnings dropped 24% to $0.22 per share, which still beat expectations by two cents. Its adjusted gross margin, which excludes a $4 million impact from restructuring efforts, fell 130 basis points annually to 46.2%, as its inventories surged 22% to $1.2 billion.
Simply put, UA's quarter was a disaster, and seemingly confirmed that the company previously dubbed as the "next Nike (NYSE:NKE)" was becoming the next British Knights or LA Gear instead. So how did this company, which once posted 26 straight quarters of 20 percent or better sales growth, crash so quickly?
A series of unfortunate events
Most of Under Armour's growth previously came from North America. However, several major headwinds knocked that market off course. First, Adidas (NASDAQOTH:ADDYY) struck back with celebrity-designed shoes like Kanye West's Yeezy shoes and aggressive expansion and marketing campaigns. That's why Adidas' North American revenues surged 26% annually on a constant currency basis last quarter even as Under Armour's business crumbled.
Meanwhile, constant competition from Nike fueled big bidding wars for big athlete endorsements, which weighed down UA's operating margins. Looking ahead, UA's top athlete-endorsed shoe, the flagship Curry line, could still face weaker sales as consumers flock toward Nike's LeBron James and Kevin Durant brands.
To exacerbate that pain, Sports Authority -- once the biggest sportswear retailer in the US -- filed for bankruptcy last year, flooding the market with excess inventory.
A series of baffling strategies
As UA struggled to preserve its margins amid that flood, it pursued a scattershot strategy that has baffled many investors. It invested heavily in its tiny connected health and wearables business, even as Fitbit's crash indicated that the market wasn't that hot.
As a result, UA's Connected Fitness unit posted an operating loss of $44.6 million last quarter, compared to a loss of $8.5 million a year earlier.
UA then tried to simultaneously expand into the low-end and high-end markets. To expand its reach in the low-end market, it struck deals with discount retailers like DSW and Kohl's. To stay in the high-end market, UA launched new Curry shoes and worked with Dwayne "The Rock" Johnson to launch the Project Rock Delta training shoes, which cost $140.
For this multi-tier strategy to work, UA needs the brand power of Nike or Adidas. But I don't think UA can pull this off without cheapening its own brand. We saw this play out with countless other sneaker brands (like British Knights and LA Gear) in the 1990s, which all tried to become the next premium footwear brand but ended up in clearance bins.
To top it all off, UA gradually increased its dependence on lower-margin footwear while reducing its dependence on higher-margin sportswear. All these decisions had a disastrous impact on its operating margins, and the situation won't improve anytime soon.
Nope, Under Armour stock still isn't cheap
With both classes of UA stock now down more than 50% over the past year, bottom-fishing investors might think that the shares are cheap enough to nibble on. They're not -- the Class A shares trade at 38 times next year's earnings, and the Class C shares have a forward P/E of 34. Those are lofty valuations for a company that is expected to post just 8% sales growth and an 18% earnings decline this year.
I've said it before, and I'll say it again -- Under Armour is a broken company in a very tough sector. If you insist on buying a footwear stock, stick with known winners like Adidas or niche growers like Skechers, which both have much brighter prospects than UA, which looks a lot like the next LA Gear.
Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Fitbit, Nike, Skechers, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool recommends DSW. The Motley Fool has a disclosure policy.