UAA - Under Armour Q3 Results Preview: Not Yet The Quarter That Will Change The Game

Summary

• Under Armour is actively taking action to spark sales growth but investors should not expect game-changing results in 3Q.
• New CEO appointment could be a strong catalyst for the stock.
• Stock trades at a significantly low EV/Sales multiple compared to leading peers.
• Under Armour is slated to announce 3Q2023 results on February 9, 2023.

Investment Thesis

Under Armour ( UAA ) is a potential turnaround story that the market does not put too much hope on. There is significant scope for accelerating revenue growth, expanding margins, and boosting valuation multiples to get closer to peers. Under Armour is a good brand but needs some work to make it great and spark sales growth. Management recently refined its target audience to be 16- to 20-year-old young athletes and plans on introducing “Live”—as a new product line. The company appointed a new CEO that will join on February 27, 2023. This change in management is likely to be the catalyst that is needed to revitalize the brand.

The company saw significant pressure on the gross profit margin over the last 3 quarters largely due to external factors—which should start to unwind in the next fiscal year. Also, I do not believe that Under Armour should trade at such a steep discount on EV/Sales to both Nike ( NKE ) and Lululemon ( LULU ). I am not making a case for parity, but I do not see a reason for Under Armour's stock to trade at a fourth of these peers’ EV/Sales multiples. Finally, Under Armour has a strong balance sheet that is cash rich, low on debt, and free from excess inventory. 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 is to Buy.

Key News Going into The Quarter

Under Armour recently appointed Stephanie Linnartz as President, Chief Executive Officer , and member of its Board of Directors and she will assume her duties on February 27, 2023. Analysts have reacted positively to this announcement despite that Linnartz comes from a different industry. They argue that Linnartz has a lot of transferable skillsets in digital, customer experience, as well as loyalty programs. In addition, I believe that Linnartz could also represent the change that is needed for the brand to bolster its position in the women’s division. However, Linnartz will require time. She needs time to adjust to the new industry and come up with an elaborate new strategy. Thus, it will require several more quarters to get a chance to see her impact on the company’s performance. Investors should not expect any major development in this regard in the upcoming earnings results (Linnartz will not be on the upcoming earnings call ).

Inventory Levels Are Likely to Continue Trending Upwards in 3Q but Not in an Alarming Way

Inventory levels for Under Armour have been rising over the last three quarters. However, this is an intended result of management actions . The company had previously been constraining inventory levels and now they are normalizing to optimal levels. In the previous earnings call, management highlighted that the inventory is mostly fresh and has very little aged stock. Moreover, the company anticipates that inventory will grow by 40% YoY in 3Q before closing the year at 30% YoY.

Figure 1: Inventory Levels

Sales Mix is Tilting Towards Footwear

In 2Q2023 footwear was the star category, as Under Armour managed to post a 14% YoY growth in footwear. This strength in footwear was broad-based and reflected good performance from many products. Apparel dipped by 2% YoY as the company pointed at softness in the “Training” category. Accessories were down due to the drop in the sales of sports masks.

Figure 2: Sales by Category in 2Q2023

Management Guidance for 3Q2023

The company provided guidance for 3Q2023 (Figure 3 below) during the earnings call of 2Q2023. The guidance highlights the same trends that were there in the previous two quarters of the year, which included muted sales growth and significant pressure on the gross profit margin. Two key contributors to the pressure on the gross profit margin have been rising freight costs and competitive pressure from higher-than-usual discounting by competitors. The company expects the negative impact of rising freight costs to abate in 4Q and act as a tailwind in FY2024. The guidance for EPS points to a high drop in profitability. I suspect this is amplified by a tax gain in the comparable quarter last year.

Figure 3: Summary of 3Q Guidance

Valuation

Nike and Lululemon trade at a TTM EV/Sales multiple of 4.06x and 5.33x , respectively. While Under Armour trades at a TTM EV/Sales of 1.13x , 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.

Key Risks

A key risk for the stock is the level of competition in the apparel market at the moment which is leading to higher-than-usual promotional activity (which itself is a reflection of the weaker economic conditions). Higher promotional activity leads to gross profit margin erosion and negatively impacts the profitability of the company. Another risk for the stock is the significant exposure it has to foreign currency, as 36% of its revenue was generated outside North America.

Final Thoughts

Under Armour has a good brand and a very healthy balance sheet. Moreover, the stock trades at a big discount to its leading peers. All that is needed for the stock to explode is a spark in sales growth. Management is cognizant of this and has started to take corrective action. I believe that the appointment of the new CEO could be the catalyst that this stock needs to start the rerating process. I see a lot of upside potential for the stock over the medium term. This is a risky call over a longer time horizon. My recommendation for the stock is to Buy.

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