Source: Under Armour
Despite posting its 22nd straight quarter of more than 20% year-over-year revenue growth, shares of Under Armour (UA +0.00%) still fell following its third quarter earnings release. Most of the market's sour reaction stems from Under Armour's declining margins.
But as you will discover below, the lowered profit margin is a non-issue, and the sell-off could make for a good buying opportunity.
Profit margin hits two-year low
On Oct. 22, Under Armour reported sales up 28% and income up 13% year-over-year. Management increased its revenue and income guidance for the holiday season, including a 21% earnings bump to about $177 million.
But even though income continues to rise steadily, the company reported lower margins and warned that they are likely to decline further. Gross margin during the quarter was 48.8%, compared with 49.6% in the year-ago period, and profit margin for the trailing 12 months dropped to 5.8%. Compare that to the 11.25% profit margin at Nike that continues to grow.
UA Profit Margin (TTM) data by YCharts
Under Armour bets on the future
However, this shrinking margin is not necessarily a negative development -- it actually shows how Under Armour is investing in its future to continue driving growth and innovation. As CEO Kevin Plank said during the third quarter earnings call, "We are experiencing powerful brand momentum in 2015 and we continue to invest to capitalize on our success in the near-term while establishing the foundation for sustainable growth in the future."
While many of these bets are costing the company a good deal of money right now, these investments are paying off with market share growth and new lines of business. Here are four areas Under Armour is investing heavily.
Endorsements and sponsorships
Under Armour has been incredibly successful building brand awareness over the last year through sponsorships of winning athletes like Jordan Spieth and Steph Curry, as well as a a growing list of college athletic sponsorships such as the recently signed University of Wisconsin deal. These endorsement deal are not cheap, but so far, they have paid off very well as Under Armour grows its various segments like football, basketball, and golf.
Rise in footwear
The company's most impressive segment recently has been footwear, which grew sales 61% year-over-year as Under Armour came out with new SPEEDFORM running shoes, Curry basketball sneakers, and football and soccer cleats. Next up, the company plans to release UA Golf shoes branded around Jordan Spieth.
The Under Armour Curry basketball shoe. Image source: Under Armour
Though the growth of the footwear segment is great for the company's overall sales and income growth, the segment typically offers lower gross margins. Therefore, as the percentage of sales from footwear increases, total gross margin and thus profit margin decline. However, the rise in footwear is undoubtedly a positive driver for Under Armour as it continues to gain market share in this segment and grow the top line at such an impressive rate.
Connected fitness
We believe Connected Fitness will enrich the lives of our consumer and we also believe it will help inform us to make better decisions on behalf of our consumer. -- Plank
The continued cost of integrating Under Armour's various app acquisitions like MapMyFitness and the building out its own UA Record app contributed to higher operating costs this year. The debt taken on to finance these acquisitions increased interest expense, and the acquisitions themselves increased Under Armour's tax rate. These combined costs helped to push profit margin down even further.
But as a result, Under Armour now has over 150 million registered Connected Fitness app users who have logged a combined 6.5 billion food items and 1.5 billion workouts as of the third quarter this year. Even though Connected Fitness revenue represents just a sliver of Under Armour's total sales currently, the company plans for this to be a major part of its long-term strategy.
Growing international markets
Overseas growth will play an important role in this story as international sales make up only 11% of Under Armour revenue, though they increased 52% over last year. Under Armour is spending now to build out its e-commerce infrastructure, helping to grow its international footprint further. During the last quarter, Under Armour launched e-commerce operations in six new countries, bringing the total up to 24 global sites.
Under Armour looks like a long-term win
Under Armour's declining margins are certainly something to watch, as even a 1% decrease in profit margin will have a major impact on the company's ability to continue growing earnings at a rate that is acceptable for such a high-priced stock, currently priced at around 96 times earnings.
However, betting on the company for short-term gains based on cost-cutting probably isn't a good idea. This is a growth story that requires a long-term mindset. The investments cited above may be hurting profit margins now, but they show us the future of what this company could be for those willing to wait. As Plank said multiple times during the earnings call, they are just getting started.
