Under Armour
Right for the wrong reasons
Earlier this week, I criticized Wall Street Wizard Citigroup for upgrading UA's shares. But pardon me if I forgo taking a victory lap on this one. For one thing, I have no desire to gloat over the downfall of a stock into which so many of our Motley Fool Rule Breakers members have sunk their hard-earned cash. For another, I had no idea that yesterday's news was coming.
When I disagreed with Citi on Tuesday, I did so based on: (1) the analyst's lackluster record in the clothing industry, and (2) UA's high valuation based on its profits of yesteryear. Skyrocketing marketing costs didn't even figure into my calculations.
But they do now
With that disclaimer of non-omniscience out of the way, let's examine what got Mr. Market's knickers in a twist. UA's news Thursday concerned its expectations for Q4, for fiscal 2007 as a whole, and its expectations for fiscal 2008.
Sales
Specifically, UA estimates that 2007 revenue will come to $605 million, a 40% improvement over fiscal 2006 sales. For Q4 in particular, that means UA is predicting $173 million in sales -- slightly ahead of Wall Street's expectations, and also ahead of UA's own past guidance.
Profits
Profitwise, management told us to expect either $1.03 or $1.04 per diluted share this year -- again, higher than both Wall Street or UA was saying before.
Inventories
Sounds pretty good so far, huh? The numbers above certainly hold nothing that would justify a 20% slice off UA's market cap. So here's where we start delving into the "bad news." First off, the inventory problems that I've highlighted so many times in the past continue to plague the company. Management warned that inventories at the end of Q4 may have risen as much as 10% compared to Q3.
In the worst case, therefore, we're looking at potentially $167 million worth of unsold clothing and footwear cluttering up UA's warehouses. To put that in perspective, if we take UA's sales and inventory predictions at face value, Q4 this year showed 40% growth in sales, versus ... 106% growth in inventories. Now, that may not be as bad as it sounds. After all, UA is trying to break into the shoe market, and to do so, it needs shoes to sell. A good deal of the growth in inventories may well have been footwear -- but it's also likely that non-shoe inventory also outpaced sales growth.
Stinky shoes
Mr. Market has forgiven UA's inventory transgressions in the past, though. So from where I sit in the bleachers, today's sell-off smells more like a reaction to what UA had to say on the subject of next year's earnings -- specifically, those earnings' 90% drop from previous expectations.
Yes, you read that right: 90%. Wall Street predicted that UA would likely earn $0.26 per share in Q1 2008, and another $0.13 in Q2. Management burst that bubble yesterday, citing the expense of "a year-long brand campaign [launching] Under Armour's Performance Training footwear, [which] will include a 60-second TV spot in the upcoming Super Bowl XLII," and advising that much of this spending will occur in the first half of 2008. UA warned yesterday that its profits for Q1 and Q2 combined will amount to about $0.04 per share.
Do I smell opportunity?
However, UA is shifting its marketing spending -- not increasing it. Six-month profits may be down, but if that means less marketing spending in the second half, there might be a corresponding increase in profits in the second half of the year, beyond what Wall Street has thus far expected.
In fact, UA hinted as much, reiterating its "long-term growth targets" of 20% to 25% for both sales and profits. The company said it expects to exceed these targets when all the pennies have been counted at year's end. According to management then, the worst-case scenario looks to me like 26% growth on this year's $1.03, for a total of $1.30 per share. That's just a penny short of the Wall Street consensus, and remember -- that's the worst case.
In my opinion, that means UA now sells for about 22 times 2008 estimates, with management still promising 20% to 25% growth thereafter. That works out to about a 1.0 forward PEG ratio. That not only sounds fair, but also cheaper than Nike's
If you think either of those two have brands superior to UA, or you just plain can't pass up a bargain, you'll probably want to place your bets with them. Me? I have to conclude that Mr. Market is overestimating the negativity of Under Armour's news. Thanks to today's markdown, this one's finally starting to smell like a "buy."
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