UAA - Under Armour Q3 Results Commentary: Inventory Is Piling Up

Summary

• Under Armour's underlying performance in 3Q was weak despite posting good headline numbers.
• Inventory rises well ahead of management guidance and seems to be sticky.
• The gross profit margin crumbles on intensified promotional activity.

Investment Thesis

Under Armour (UA) ( UAA ) is a potential turnaround story that the market does not put too much hope on. There is scope for accelerating revenue growth, expanding margins, and boosting valuation multiples to get closer to peers. However, this requires significant effort from Under Armour to spark sales growth. Macro headwinds and intense competition could mean that we are several quarters away from such a potential recovery. Even though there could some pressure from inventory in the short term, Under Armour’s balance remains a source of strength given that it is cash rich and low on debt. This balance sheet should prove to be pivotal in the turnaround story and further extend the company’s share buyback program. I have a positive view of the stock over the medium term and my recommendation remains “Buy.”

3Q Sales Growth Spurred by Footwear

Under Armour posted a 3% YoY increase in sales in 3Q2023 (the company switched to a fiscal year that ends March 31). The source of this strength was in footwear , where the category posted a 25% YoY increase in sales and accounted for 23% of sales in the quarter (compared to 19% in the prior year). Growth in footwear was broad-based and spanned multiple products.

From a regional perspective, EMEA (Europe, Middle East & Africa) was the best-performing region with 32% YoY growth in sales. However, management pointed out that some shipments to EMEA in 3Q2023 were originally planned to be delivered in 4Q2023. Thus, it is very likely that EMEA brought forward some sales during the quarter. Overall, total sales growth of 3% YoY was slightly above the higher end of management’s guidance of 2% increase.

Figure 1 Revenue Continues to Grow in Low Single Digits

Figure 2 3Q2023 Sales by Category

Gross Profit Margin Craters but Lower SG&A Drive Increase in Operating Profit

In the 2Q2023 earnings call, management had guided for the 3Q2023 gross profit margin ((GPM)) to fall to the range of 44.7% to 45.2%; however, the actual result came in at 44.2%. Management indicated that the promotional activity was very high in the quarter and they do not expect this to ease over the next couple of quarters. Under Armour’s headline numbers were good because the company posted a strong decline in SG&A. However, the market took this negatively as the pressure on the GPM is likely to prove stickier than the sources of the SG&A improvement. Figure 4 shows how the TTM GPM has been deteriorating over the last 4 quarters.

Figure 3 Summary of Results

Figure 4 TTM Gross Profit Margin In Freefall

Inventory Levels Spike for the Same Reasons as Decline in GPM

Inventory is bloating at a much faster rate than the market was expecting and is not showing signs of a recovery in the near term. Inventory jumped by 50% YoY, ahead of the guidance of 40% YoY growth. I do not think this in itself is what spooked the market but rather the new guidance that inventory is likely to also grow by 50% YoY in 4Q2023. Previously management had guided for a 30% growth in inventory in 4Q2023, as it had anticipated the rise in inventory was seasonal. Promotional activity seems to be very strong and the company is feeling the pressure in both the GPM and inventory.

Figure 5: Inventory Levels

Management Guidance for FY2023

The company provided guidance for FY2023. Revenue growth is expected to be in the low single digits (unchanged). GPM is now expected to fall by 425 basis points, the higher end of the previous guidance. Operating profit guidance remains unchanged at $270 million to $290 million. Management upped its adjusted diluted FY2023 EPS guidance from $0.44 to $0.48 to $0.52 to $0.56. However, this better guidance for FY2023 was overshadowed by the gloomy picture that management painted about the dynamics of the industry.

Key Risks

In my previous article , I had a section on key risks where I pointed out that the higher-than-usual promotional activity in the market presents itself as a key source of risk for the stock. This seems to have materialized following the latest results as the gloomy outlook from management has spooked investors. Higher promotional activity will likely be a key challenge in the next couple of quarters and could make the job of the new CEO significantly harder. Other risks include a slowdown in sales in EMEA, which has been the outperforming geography this year.

Valuation

Nike ( NKE ) and Lululemon ( LULU ) trade at a TTM EV/Sales multiple of 4.0x and 5.5x , respectively. While Under Armour trades at a TTM EV/Sales of 1.0x , without adjusting for the large cash balance. The growth profile of NKE and LULU are indeed significantly higher at the moment, but Under Armour has good potential to post double-digit sales growth. Thus, I believe that the market is heavily discounting the possibility of a turnaround in Under Armour, and that tilts the risk/reward profile for the stock to the upside over the medium term.

Final Thoughts

Management did not paint a rosy picture for the next couple of quarters. Investors were spooked by the impact of promotional activity on both the GPM and inventory. This indicates that the road ahead for Under Armour is going to be bumpy, but we should not lose sight of the work that is being made to reposition the company. The impact of these changes will take time and may test investors’ patience with the stock. Accordingly, the stock price itself will likely witness high levels of volatility. However, I believe that the appointment of the new CEO could be the catalyst that this stock needs to start the rerating process. There is a lot of upside potential for the stock over the medium term. This is a very risky call over a longer time horizon. My recommendation for the stock remains “Buy.”

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