Why You Should Sell Under Armour To Buy These 2 Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As we move towards the MLB playoffs and excitement begins to build for the NFL, growing demand should follow in the sports retail / apparel business. Nike (NYSE: NKE), Under Armour (NYSE: UA), and Foot Locker (NYSE: FL) should see a cyclical rise in sales from those categories. At the same time, only Nike and Foot Locker are worthy of an investment.
Nike & Foot Locker
Both Nike and Foot Locker are at premiums to the S&P 500. Whereas Nike trades at 20.5x past earnings, Foot Locker trades at 17.1x past earnings. Analysts currently expect the latter to grow EPS by 12% annually over the next 5 years, around 170 bps more than what is expected for Nike. In my view, Nike is not an incredible "buy" but could be worth a slight investment off of growing expectations for greater sales. Its ROA, ROE, and ROI are all in the high double-digits.
One particular area that could drive appreciation for Nike is the downfall of Reebok. Nike recently became the official apparel supplier for the NFL and also has struck an alliance with Apple in iPhone 5, which has thus far seen terrific sales. Management has also showcased confidence over future free cash flow streams by announcing a plan to repurchase $8 billion worth of shares. To put this into perspective, the company has repurchased "only" $10 billion worth of shares over the last decade. With that said, earnings of $4.73 per share were $0.19 below consensus. This poor performance was the result of a margin decline offsetting revenue increases in major geographies.
Foot Locker has done well with 2Q sales up 9.8%, even in Europe. What concerns me, however, is how the company had a net closure of 15 stores, which suggests either a cautious outlook or an interest in increasing sales per square foot. Fortunately, all of the last 5 quarters have beaten analyst expectations by at least double-digits. With a current ratio of 3.4, the company is cash rich for accretive takeover activity. It should consider buying more locations, not decrease them, to improve visibility and edge out other sports retailers in market share. It is this long-term excitement over what the company expects to do with its $687 million in net cash that compels me to recommend buying stock.
Under Armour
UA may be an attractive brand and company, but it isn't really "affordable." At a respective 60.7x and 37.1x past and forward earnings, UA would require considerable growth to justify its current valuation. Analysts already forecast 24.6% annual growth over the next 5 years alone (versus the 18.6% that was achieved over the past 5). Despite this aggressive projection, the PEG ratio is still astronomical at 2.5x. What could possibly drive value if not the future growth?
Perhaps market excitement. Like Footlocker, UA has a strong balance sheet to play with. The current ratio is at 3.1x, long-term debt is virtually nonexistent, and the brand continues to see strong returns. All of the last 5 quarters have beaten consensus, but free cash flow generation has been poor. For the TTM ending 2Q12, a loss of $713,000 was generated. This compares to a positive generation of $76 million just two years ago. How can a company go from an average of around $60 million between 2009 and 2010 on a TTM-basis to negativity territory and still be worth north of $5.9 billion?
As high as the historical 5-year average PE multiple of 39.7x is, the firm has become increasing expensive since around the end of 1Q09. In fact, on a PE basis, the company is getting back to the pre-2008 levels when it was just starting to emerge as a "hot stock." Accordingly, I strongly recommend avoiding the stock and buying a stake in Foot Locker and Nike as those 2 stocks could possibly expand their multiples to become more in-line.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Under Armour. Motley Fool newsletter services recommend 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.
