With a stock up nearly 30% in a mostly flat market, Under Armour (UA 1.08%) is one of the most successful equities an investor can buy today. And yet, one well-respected investment banker is saying that this may not always be the case.
This morning, analysts at Cowen & Co. announced they're ratcheting back expectations for the sportswear specialist. Although Cowen is sticking with its "outperform" rating on the stock, and continuing to hope for a rise in the stock price, Cowen's less sanguine about how high Under Armour can go -- and is cutting $10 off its price target, dropping Under Armour to $110.
But why?
Rising costs, writedowns loom
As sketched out on StreetInsider.com this morning, Cowen's thinking goes basically like this:
Historically, Under Armour has spent about 3.5% of the revenue it takes in on capital expenditures. However, the cost of "capacity investments, international store growth, IT development and a headquarters expansion in Baltimore and overseas" are all causing capital spending to shoot up rapidly. Indeed, over the next three years, Cowen expects Under Armour will have to devote anywhere from 8% to 10% of revenue to capex -- roughly three times as much as normal.
That could be a problem for Under Armour, which is now rapidly "burning through cash." According to data from Yahoo! Finance, Under Armour only has $159 million in the bank today (against more than $900 million in debt). Yet at the same time, S&P Capital IQ reports that the first three quarters of 2015 have seen the shoe specialist rack up $313 million in negative cash from operations -- and then spend an additional $227 million on capex. Combined, that adds up to nearly $540 million in negative free cash flow this year.
At the same same time, Cowen worries that Under Armour may need to write down the value of some of its inventory "due to the weather," and that this could hurt profit margins, drying up cash flows. Inventories are rising among sportswear retailers, and this could pressure Under Armour to sell some of its goods at a discount in order to move inventory before it goes out of style.
All of which certainly sounds worrisome. But is Cowen right to worry?
Let's go to the tape
It depends on how you look at the data. On the one hand, Cowen is undeniably one of the better stock pickers on the market today, with a ranking in the top 10% of investors that we track on Motley Fool CAPS.
On the other hand, Cowen's record in the Textiles, Apparel and Luxury Goods industry is anything but consistent. With a record of just 50% accuracy in this sector, Cowen has turned in some incredible hits over the years -- and some even bigger misses:
|
Company
|
Cowen Says: |
CAPS Says: |
Cowen's Picks Beating (Lagging) S&P By: |
|---|---|---|---|
|
GIII Apparel |
Outperform |
**** |
328 points |
|
Deckers Outdoor |
Outperform |
**** |
128 points |
|
Fossil Group |
Outperform |
*** |
(37 points) |
|
lululemon athletica (NASDAQ: LULU) |
Underperform |
*** |
(1,023 points) |
In short, an investor making a bet on Cowen's recommendation -- based solely on the analyst's record of being right or wrong -- appears to have just as much chance of going wrong.
Valuing Under Armour
This is precisely the kind of situation in which it makes sense to double-check an analyst's thinking by working our own valuation of the stock. And in Under Armour's case, I have to say that that valuation is looking a little stretched.
Consider: At last report, Under Armour had earned just under $215 million in GAAP profit over the past 12 months. Relative to the stock's $19.9 billion market cap, that works out to a P/E ratio of more than 92. For comparison, Lululemon -- one of Cowen's worst picks ever (albeit a pick to underperform) costs "only" 28 times earnings. And at last report, Lululemon was generating positive free cash flow, whereas Under Armour is currently burning cash.
The upshot for investors
Granted, analysts on average expect Lululemon to grow more slowly than Under Armour, increasing earnings about 18% annually over the next five years, versus Under Armour's 23% growth rate. But even so -- sacrificing five points of growth may be worth it if the reward is a stock price 70% cheaper than what Under Armour costs.
In short, while I'm not particularly enthusiastic about the valuation of either of these stocks -- Lululemon or Under Armour -- the overvaluation is significantly more obvious at Under Armour than at Lulu.
And Cowen is right to be cautious.
