Does This Athlete Need a Rest?

By Chad Henage - July 23, 2012 | Tickers: LULU, NKE, UA | 0 Comments

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Everyone understands that when an athlete gets tired, even the best have to come out of the game sometimes. That was the argument made by Dan Caroll of The Motley Fool about Under Armour (NYSE: UA) recently. He made several key points that he believes show that Under Armour should be, "...cut from your portfolio." 

Dan's concerns were that Under Armour sells for a high forward P/E ratio, and that Amazon.com is also entering the sporting goods arena, which could upset the companies big-box retail partners. In addition, he made the comment that if Dick's Sporting Goods is challenged, that Under Armour could take a hit. Last but not least, he brought up the tired argument that Under Armour carries too much inventory. While the higher forward P/E ratio isn't disputable, his other two arguments just don't hold water.

There Are Over 12,000 Reasons Amazon.com Isn't A Problem:

First, Amazon already sells Under Armour products and if anything this should help the company's distribution going forward. In fact, if you search the words "Under Armour" on Amazon.com as of right now there are 12,888 results. With the Under Armour brand showing up in men and women's clothing, shoes, and accessories, it appears the company is well represented on Amazon.com already. Making the argument that if one big box retailer has problems with Amazon.com, that an individual brand would suffer seems shortsighted. In my eyes, this is the same as saying that any number of retail brands should be concerned because Amazon.com carries their wares. Under Armour would prefer customers buy directly from the Under Armour website. However, if it means additional sales, I'm sure the company is comfortable with customers choosing Amazon.com as their shopping destination. In fact, if any company should be concerned about Amazon's lack of their brand, it should be Lululemon (NASDAQ: LULU). On Amazon's website, there are only 394 results for this particular brand, versus over 82,000 results for Nike (NYSE: NKE). Though Amazon is a dominating online retailer, they are technically just another distribution site for the Under Armour brand. If Dick's suffers because Amazon picks up business this shouldn't make much difference to Under Amour.

Competition:

Where Dan's argument about the relative valuation of Under Armour stock is concerned, there's no question the stock is more expensive than either of the previously named competitors. Even using 2013 projected earnings, Under Armour sells for about 33 times this number. By comparison, Nike sells for about 16 times 2013 earnings, and Lululemon sells for 27.69 times 2013 projections. To get a better idea of the relative competitive position of Under Armour, let's compare these three companies on a few additional measures. 

You can see that based on these numbers, one reason investors might be willing to pay up for Under Armour stock, is the company has beaten earnings by the largest average amount. While the companies expected growth rate is lower than Lululemon, because of the aforementioned earnings beats, investors might believe this growth rate is too low. When it comes to gross margin, there's no question that Lululemon is the category leader. This leaves Nike as seemingly the odd man out, with a much lower expected growth rate, and the lowest gross margin of the three. While on the surface, it appears that Lululemon could be the better value, as you can see the numbers are not as simple as Dan paints them to be. The one argument about Under Armour that I'm getting the most tired of hearing, is the "bloated inventory" argument.

Can We Send This Tired Argument To The Showers?

There are two points that I would make to prove that Under Amour's inventory is not a problem. First, while Under Armour does carry more inventory relative to its sales, this has not been a problem in the past. As proof of this, take a look at the last four quarters, comparing inventory levels to sales levels:

(sales and inventory in thousands) 

You can clearly see the percentage of inventory varies between 68.5% up to over 106%. However, during the same timeframe, the company has not only grown, but beat earnings estimates on a consistent basis. In addition, I would make the point that overall inventory in the last four quarters has only grown by about $13 million. During the same timeframe, sales have grown by over $90 million. Since sales growth is clearly outpacing inventory growth, this argument needs to be put to rest.

Conclusion:

While it's true that Under Armour is more expensive than either of these two competitors, the company is constantly introducing new products and entering new markets. You could make the argument that Lululemon has the best overall valuation, but to say that Under Armour needs to be "cut from your portfolio," I believe is an overstatement. If the company continues its current growth track, and continues beating earnings estimates, the shares could represent a decent value.

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