After unveiling its HealthBox at the Consumer Electronics Show in Las Vegas, Under Armour (NYSE:UAA) got a lot of press and generally had people excited. However, that mood quickly changed after Morgan Stanley (NYSE:MS) released its report on the company, and cut its rating significantly.
In this clip, Vincent Shen and Sean O'Reilly talk about Under Armour's performance over the past several years, what the Morgan Stanley data showed, what areas of the report were particularly interesting and how Under Armour might have to adjust its strategy.
Listen to the full podcast by clicking here. A full transcript follows the video.
This podcast was recorded on Jan. 12, 2016.
Sean O'Reilly: Dylan and I chatted about Under Armour on the tech show last Friday, but it was mostly in a positive light because of their showing at CES and their rollouts of, you know, Fibit competitors and all that stuff. But unfortunately, you and I have to chat about Under Armour in more of a negative light because of recent events. So, what happened yesterday?
Vincent Shen: Yeah, absolutely. I think it's really funny because, like you mentioned, last week you and Dylan were talking about how the company (I'm sure) spent countless hours and a ton of effort preparing this big launch for themselves at CES of this suite of products they're offering.
O'Reilly: And it was a hit.
Shen: $400, you get the scale, the chest band, other wearables ...
O'Reilly: A heart monitor that's actually by your heart and not on your wrist (laughs) ...
Shen: Yeah, exactly. A whole fitness suite, essentially. That generated quite a bit of buzz at the event. But then they start this new week on Monday with Morgan Stanley, their equity research analyst, putting out this very bearish report on the company, cutting it to a sell, essentially, reducing the price target some 40%.
O'Reilly: What is it, so that's like $40 or something? Or $50?
Shen: Yeah, it was reducing it significantly to about $62, I think below even where it's trading now.
O'Reilly: We might be getting ahead of ourselves here. Did they talk about valuation at all? Because that stock has a high P/E, like it always does, so ...
Shen: There's no denying that. Right now, in terms of forward earnings, I think it's trading about 51 times. Definitely high valuation. You have to keep in mind, the stock gained 19% in 2015.
O'Reilly: Not bad, yeah.
Shen: And that's on top of gains that it has put up ... It has logged strong gains -- double digits I'm pretty sure for most years -- since 2009. Seven straight years of gains at this point.
O'Reilly: So what do those reports say? Because Morgan Stanley comes out, are they just being negative just to be negative? What's the deal?
Shen: Sure thing. I think there's two main points in the report that I want to cover and get to. I think in this case, sometimes these reports come out, they ding the stock, and it's not really something that's fundamental to the business. It's more of a near-term volatility. This is an instance where I actually do think it touches on very important issues for this company. If you think about Under Armour and what they've mentioned as being some of their pillars of growth: women's apparel, men's apparel, their international business, e-commerce, things along those lines ...
O'Reilly: Shoes ...
Shen: Women's apparel's been a big part for them. It's been growing very, very quickly, far outpacing their men's division. And the company has invested a lot to develop that part of their business. 2014-2015, I think they spent something like $15 million on the marketing campaign with some really famous athletes. The one that I remember seeing and thinking was really cool was with Misty Copeland, and has her narrating over the video about how people were doubting her and showing her ... And also, Giselle Bundchen had her commercial with Under Armour as well.
So a lot of buzz around that, and it was part of their efforts to build up their women's business. And now you have this report coming out saying, growth has gone from double digits essentially to stalling for the last six months of 2015. Stalling to essentially flat for the women's business, which makes up about a third of their total business at the moment.
The second issue to really ding them is how, for their footwear, they've seen average selling prices fall since the beginning of 2013, so about the past three years. Average selling prices for their running shoes have fallen 20%, versus 4% for the broader industry. The two ways that this rolls in, like I said, women's apparel being really important, but also in terms of the company's overall brand image ... It's always been high performance at a premium. High quality at a premium.
But with those average selling prices, there's concerns now among investors that all of a sudden, if there's this shift where the company must compete more on price, you're going to see ... obviously, margins are going to start compressing, the average selling price is going to continue to fall. What impact that's going to have on their growth rate, which a lot of analysts are expecting to grow 20% to 25% annually over the next five years. Is that sustainable?
And so it really changes all of a sudden the trajectory that this company might take. It's an interesting look into this report, how it touches on two really important things for them.
Sean O'Reilly has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.