“I Will,” or Maybe I Won’t
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I have a difficult time not buying stock in companies when I buy their products on a regular basis. One such company is Under Armour (NYSE: UA). My personal experience with Under Armour clothing and shoes is that they are very high quality and very comfortable. In fact, since my wife and I tried Under Armour shoes, we have recommended them to almost everyone we know. However, recommending Under Armour stock is a little more difficult.
This Is a Great Company That Could Do so Much Better
Don’t get me wrong--I’ve owned Under Armour stock in the past, and been very pleased with the results. However, once the stock gotten past a certain valuation, I could no longer justify continuing to own the shares at such lofty prices. There are several issues facing Under Armour, and in an industry with competition such as Lululemon (NASDAQ: LULU) and Nike (NYSE: NKE), the company can’t afford to be second best at anything.
When a company reports revenue growth of 23%, and this is evenly spread across each of their divisions, you would expect good earnings growth as well. However, due to promotional spending and incentives, Under Armour saw a 50% decline in diluted EPS. For a stock selling at a forward P/E ratio of 40.51, a decline in earnings like this should be a red flag.
Consistency in Revenue and Earnings Growth
The first thing investors need to keep an eye on is Under Armour's earnings growth rate. Currently, analysts expect the company to grow earnings by just less than 21% in the next few years. In past quarters, the company exceeded 20% earnings growth. However, looking at the 50% decline last quarter, investors need to see if the company can get back on track.
When you look at Under Armour's peer group, Lululemon is expected to grow earnings faster than Under Armour at 22.24%, versus 20.83%. Nike isn’t expected to grow as fast as these two companies at about 10% EPS growth, but Nike is also a much larger company as well.
It’s acceptable for the company to show a large decline for one quarter based on certain expenses, but if this becomes a trend, Under Armour would be in serious trouble.
A second item to watch is continued momentum in revenue growth. Analysts are generally expecting an over 22% increase in revenues this year from the company, and anything less would be a major blow to investor’s confidence. In fact, Under Armour is expected to grow revenue faster than Lululemon, from which analysts expect 21% revenue growth. In contrast, Nike is only expected to grow revenue by 4.9%.
Not This Again
Third, investors need to see that Under Armour is able to maintain a high gross margin. Last quarter, the company’s gross margin was 45.9%, which was second only to Lululemon at 49.37%. Though Nike turned in a respectable 44.22%, the Nike brand is generally more broad-based than the other two, which accounts for the difference.
A fourth issue that Under Armour shareholders need to take a look at is the company’s inventory management. Several quarters ago, it seemed that management had solved this long-running problem. However, the company’s inventory compared to their current quarter sales was the highest among their peers in the last three months.
Nike is more established and should understandably have its inventory under control. The company did fairly well, with about 54% of current quarter sales held in inventory. Lululemon is a much smaller company, but was able to manage with just 41.56% of sales in inventory.
Under Armour took a step backward and seemed to carry too much inventory at 68.6% of current quarter sales. Considering that Nike is more established, it would be one thing if Under Armour carried more inventory than its larger peer, but underperforming Lululemon doesn’t make a lot of sense.
The Company Says “I Will,” But Maybe You Should Not
Under Armour's new slogan is "I Will," but the company’s next earnings report may decide whether or not shareholders say "I Will" to holding Under Armour stock. The company quite honestly needs to get inventory under control once and for all, and be more careful about their spending. Management also needs to make sure that its spending doesn’t trip up earnings growth.
Any time a stock trades for a P/E ratio that is nearly double its growth rate, the company needs to report good results. Under Armour shareholders will likely demand better results this next quarter than the company turned in a few months ago. Otherwise, the Under Armour growth story could be in trouble. Instead of saying “I Will,” investors just might say “I’ll Sell” instead.
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Chad Henage has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica, Nike, and Under Armour. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!