Are Under Armour Shares Overvalued?

As of Tuesday's market close, Under Armour (UA +4.67%) was valued at around $18 billion. The company is closing in on $4 billion in revenue, and has reported just over $200 million in profit over the past 12 months.

By comparison, Adidas (ADDYY +0.81%), a $20 billion company, achieved $18 billion in revenue and over $700 million in net income over this stretch. And Nike (NKE +2.02%) became a $20 billion company in 2004 -- its 43rd year of existence. At that time, Nike finished the year with $12 billion in revenue, and $946 million in net profit.

To put Under Armour's valuation in perspective, its market capitalization is roughly in line with Adidas, the world's second largest sportswear retailer, despite having less than a quarter of the revenue. When Nike was trading at Under Armour's level, the company had almost seven times the profit -- not adjusting for inflation.

Today, Under Armour trades at a multiple of 86 times last year's earnings and nearly five times sales, which is much richer than its closest competitors. This makes it seem like Under Armour's stock is overvalued, but if you dig a little deeper into the company that might not be the case.

Data Source: Capital IQ

Valuation
Under Armour CEO Kevin Plank recently updated investors with a 2018 revenue projection of $7.5 billion -- nearly double today's sales numbers. Let's take a look at what this may mean for the stock.

Data Source: Company Filings

Before calculating a simple valuation of Under Armour, let's walk through the 2018 assumptions used above:

• Revenue: As mentioned, the company expects to reach $7.5 billion in revenue in 2018. Under Armour has been known to give conservative guidance to investors. At the company's Investor Day in 2013, for example, the company said that expected $4 billion worth of annual sales by 2016. They are going to reach that target a year sooner than expected. Despite Under Armour management's conservatism, I will stick with $7.5 billion for valuation purposes.
• Net profit margin: Under Armour's net profit margins have averaged 6.8% over the past five years. However, margins declined over the last year as footwear, a lower margin product line, has become a more meaningful portion of Under Armour's revenue. Additionally, Under Armour continues to aggressively invest in marketing and Connected Fitness, its digital health and fitness platform. I believe footwear sales will continue to grow and I don't expect Under Armour to take its foot off the pedal when it comes to investing in its business. However, the company should be able to offset some of its margin decline as it achieves economies of scale and operating efficiencies. Under Armour can also expand margins as it continues to grow its higher margin direct-to-consumer business.

Data Source: Company Filings

• Shares outstanding: Under Armour has increased its share count from 164 million to 216 million since 2010, diluting shareholders 5.6% annually. The company has taken on debt, and as the company matures it should be able to utilize profits to fund future growth. Therefore, I assumed a slightly slower dilution rate of 5% over the next three years.
• Earnings per share: Armed with an estimate of revenue, net profit margin, and shares outstanding, earnings per share in 2018 are projected to be $1.80.

With the assumptions above, a valuation based on projected price ratios can be computed. As Under Armour becomes a larger company it is reasonable to believe that its P/E ratio will contract. The million-dollar question is: how much?

Using Nike as a barometer, I estimated a pessimistic P/E ratio of 35 for Under Armour.

Nike is a high-performing but well-established company. Although Nike is growing, it is not growing at the pace of Under Armour, therefore, the stock typically trades at a lower P/E ratio. For the optimistic scenario I used a P/E ratio of 55, which is closer to Under Armour's average trading multiple over the last five years. Using the scenarios below, Under Armour is valued anywhere between $63 and $99.

Investors can also use the price-to-sales multiple to estimate a value for Under Armour. At $7.5 billion in revenue, Under Armour would have revenue of $30 per share. If Under Armour trades at Nike and Lululemon's P/S ratio of 3.5, Under Armour would be valued at $105 per share.

At a share price of roughly $82 today, Under Armour does not appear overvalued. If some fairly conservative assumptions hold, shares may even be undervalued.