Guidance Was Good, But Not This Good
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Sometimes companies are expected to report impressive numbers. When stocks are priced for perfection, great earnings should be the norm. With a company like Under Armour (NYSE: UA), high expectations were already built into the stock. The company reported earnings and investors acted as though a new growth rate had been assigned to this already fast-growing company. The company did guide 2012 estimates higher, but not enough to justify the roughly 10% increase in the shares in the last 2 days.
Under Armour's earnings report was impressive with net revenue growth of 27%, and EPS increasing by 6%. In addition, every category the company competes in showed significant growth. The apparel group showed net revenue up 23%, accessories grew 21%, and direct to consumer sales grew by 35%. However, what seems to have increased the optimism around the company's future growth was the footwear divisions results. For several quarters, analysts have questioned Under Armour's ability to compete against giants such as Nike (NYSE: NKE) in this highly competitive market. Under Armour is proving its doubters wrong with footwear revenues up 44% in the current quarter. While there is no question that these results were impressive, footwear still represents a much smaller percentage of overall revenue than apparel does. Until this relationship changes, apparel and accessories will still be the primary drivers of Under Armour's growth rate.
Within the apparel segment, Under Armour faces stiff competition from both Nike and Lululemon (NASDAQ: LULU). While the company is improving its women's fashion segment to compete more directly with Lululemon, this will be a tough challenge. The primary differences between Under Armour and Lululemon have to do with inventory levels and growth rates. A common argument against investing in Under Armour stock, has been the level of inventory that the company carries. In the most recent earnings report, the company mentioned that it was aggressively using its Under Armour outlets to “work through excess inventory.” A few quarters ago, the company lowered its inventory usage as a percentage of revenues to less than 100%. In the most recent report, inventory levels grew to over 103% of current quarter revenues. While it's true that revenue grew faster than inventory levels, the fact that EPS grew tremendously slower indicates that the company is having to mark down some of this excess to clear it out. By point of comparison, Lululemon's total inventory represented 37.69% of current quarter revenues. Given that analysts expect Lululemon to grow earnings in the future at a faster rate than Under Armour, this big difference in inventory shows the company is operating more efficiently. Another issue that Under Armour investors should watch carefully is, the relationship of operating cash flow growth to revenue growth.
On a year-over-year basis, while revenue grew at 27%, Under Armour's most basic operating cash flow measure grew by 19.75%. Since many companies make adjustments for balance sheet line items, looking at just net income plus depreciation shows this slower percentage of growth in cash flow. The company's cash and cash equivalents also grew by about 19% year-over-year. By comparison, Lululemon grew its operating cash flow by well over 40% in its most recent quarter. The bottom line is, while Under Armour is doing very well, that was already the expectation heading into this report.
What was really interesting was the company's improved outlook, which was cited as one of the primary reasons for the pop in the stock price. However, revenue for the company is now forecasted to fall right in the middle of analyst expectations. Meeting expectations should not equate to a 10% increase in the value of the company. Looking at the footwear industry, there are competitors at opposite ends of the spectrum that could challenge Under Armour's future growth in this category.
The two best examples I could give, are Nike and Deckers (NASDAQ: DECK). Nike has long been the category leader and currently sells for a forward P/E ratio of about 18. While the company's expected growth is much lower than Under Armour at 11.10%, the difference is Nike is already established in this space and is a consistent performer. Where Deckers is concerned, the company faces some serious short-term cost issues specifically related to their input costs for their popular UGGs footwear. That being said, the stock sells for a forward P/E ratio of less than 10, and over the long-term, analysts still expect over 17% growth in EPS. By comparison, after the most recent move, Under Armour stock sells for a forward P/E ratio of nearly 45, with 21.85% growth expected. Given that the company already traded at a significant premium to its growth rate prior to earnings, this 10% increase in the value after the earnings release seems like a bit much. When you consider that Lululemon is expected to grow faster at 27.47%, and trades for a lower forward P/E ratio of about 35, this seems like a better deal. Given the choice between a 22% grower at 45 times earnings, and an almost 28% grower at 35 times earnings, the choice seems simple. Investors should take a hard look at why Under Armour is valued so much higher with a lower growth rate. As I said before, the company's guidance was good, but not this good.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Lululemon Athletica and Under Armour. Motley Fool newsletter services recommend Lululemon Athletica, Nike, and 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.If you have questions about this post or the Fool’s blog network, click here for information.
