Description

Under Armour (UAA), a well-known sporting apparel brand trading at a low valuation and with new leadership, offers investors a multiyear appreciation opportunity via beating reasonably low earnings expectations and enjoying potentially significant multiple expansion.

COMPANY STATS

Fiscal year ends 3/31 (currently in 1Q fiscal ’24)

distribution type

Wholesale 59%
D2C: 39%
License: 2%

Retail locations

Factory: 341
Brand 98

Geography of revenue

N.A: 66%
International: 34%

product type of revenue

Apparel: 66%
Footwear: 25%
Accessories and other: 9%

POSITIONING RELATIVE TO MARKETPLACE

What’s particularly relevant in the above is that UAA – relative to peers – skews more reliant on N.A., wholesale, and apparel. Currently, this is regarded an unattractive mix. In particular, I’d highlight two points of concern which I believe will ultimately be less unfavorable than the market’s perception.

1) N.A. is at the center of an industry-wide glut in apparel inventory. This has been a lingering issue now for several quarters. While inventory levels have started to come down nicely, we still hear that e.g., offprice outlets are reported to be fairly flush with inventory, inventory may persist as a margin headwind for another 1-2 quarters. However, on balance, I believe we are well within the ‘later innings’ of the inventory issues which will restore more price discipline / gross margin improvement to the industry. Given its low valuation multiples and depressed margins, UAA is my preferred way to benefit from this improving trend. A risk here is that the consumer has simultaneously become more price sensitive lately, in part due to reduced inflation-adjusted purchasing power. This aspect is less within the company’s control.

2) Wholesale reliance, according to some, puts UAA at a relative disadvantage given the current overinventory and also lack of direct customer touchpoints and perceived foregone margin. However, I believe much of the criticism is overblown. There are several case studies and longer form research discussing profitability limitations for many companies using the D2C model. This is visible in the difficulty of pure online retailers, particularly apparel retailers, to achieve significant profit margins or even profitability at all. Amazon’s struggle in retail margin are well known. European D2C focused fashion apparel companies Zalando, Asos, Boohoo have underperformed and only achieve low single digit net margins. Farfetch, Stitchfix, and others have struggled to achieve profitability despite benefits of D2C relationships. More direct to the point, Nike has long stressed its ambition to become more D2C and it has been successful in improving its D2C penetration improving from 30 to nearly 45% D2C the past five years. However, while gross margin accretive, it has not translated to bottom line accretion as might be expected as operating expenses have grown. Basically, improved gross margin from middleman removal within D2C is structurally offset by increased logistical costs for smaller unit shipping, higher and more costly returns, increased marketing costs, and general op-ex support. For this reason, i.e., my skepticism towards the underlying economics of D2C, I regard the wholesale mix at UAA as an underappreciated relative source of value. Though for clarity, I do believe that targeted D2C efforts can be effective and I expect UAA's new CEO to improve their performance here.  

A third item to highlight in the above business mix is UAA’s 25% footwear mix. By contrast, Nike is 2/3rds footwear, evidencing an opportunity for UAA to gain  ground. This isn’t a new opportunity and so one’s relative optimism on the execution potential of new management will be key here. I think there is room for encouragement. Moreover, some green shoots are already appearing with TTM footwear sales now on an accelerating trend.

NEW LEADERSHIP AND UPCOMING FINANCIAL GOALS

UAA has recently hired Stephanie Linnartz to be CEO. Founder Kevin Plank will run product and the two will lead the company in something of a partnership. Though, Linnartz has reinforced that she will have CEO decision making. Linnartz is an industry outsider who had a 25 year career at Marriott Hotels, even gaining consideration for the CEO role there. She is also on the Board at Home Depot, which offers some more direct prior exposure to retail. Checks show Linnartz is highly regarded and has strengths across both branding and digital, two elements that were important to Marriott’s success and will be valuable for UAA.  

Linnartz has not indicated a desire to make transformation changes but has identified opportunities to (a) increase the women’s business (25% of revenue, and like footwear, also a historically-identified but unrealized opportunity), (b) improve the lower and middle tiers of a three tier product line quality, (c) innovate more (e.g., the new Slipspeed product, which is a versatile slide-on yet athletic shoe) and (d) beef up digital marketing, messaging, and collaborations. Despite being a relatively small market cap company, UAA has enjoyed successful partnerships with the likes of Tom Brady and Stef Curry. The company also is reaching out to more niche athletes to grow the brand. Of importance, Linnartz doesn't seem dogmatic and has indicated she’ll adopt an agile approach guided by ROIs.

So far, Linnartz seems to have set a conservative bar by guiding FY’24 below expectation calling for flat to slightly up revenue though several retailers have reported weakening trends since the outlook was delivered. Gross margin was also only guided 25 – 75 bps of improvement. This is coming off of a relatively low starting point given fiscal ’23 saw margins compress to 45%, roughly 500 bps from historical levels. Overall, I regard the estimates for 2023+ as having significantly more upside potential than downside risk with freight alone (prices have already dropped significantly and several other retailers guiding to more significant improvements in 2H) offering margin improvement towards the high end of the guided range and merchandising margin improvements occurring particularly upon resolution of the aforementioned industry inventory issues.

CONCLUSION

In addition to a long-term constructive view on the potential of the new CEO and exiting a period of max-fear around inventory and margin, I (and perhaps others on the Board) am drawn to UAA’s cheapness. As the company (a) makes progress improving margins (note that current ebitda margin of 8% compares to NKE @ low/mid-teens, vs. UAA historically achieving low/mid teens, vs. SKX @11%, vs. PVH/LEVI/VFC in the teens) and (b) new management and initiatives drive topline, valuation could rerate dramatically. UAA's EV / ebitda multiple is near the bottom of the peer group and EV-sales multiple (I use this to give a sense of the valuation upside leverage when coupled with ebitda improvement) is 0.65x, far lower than peers. For reference, Adidas is 1.5x, NKE >3x, LULU >4.5x, LEVI/VFC/SKX at 1.1-1.2x. Based on this valuation, and the potential for operational and company perception improvement across (a) inventory (b) margin (c) new management execution, I very much like the risk reward. 

Catalyst

- beating conservative new management guidance
- product innovation win
- new ceo proving execution capability and winning investor confidence
- resolution of apparel market weakness (will take a bit of time to work through remaining inventory and subject to consumer appetite)