2023-11-22 06:42:30 ET
Summary
- Under Armour has struggled for the better part of a year.
- However, it shows signs of bottoming, due to a better technical and fundamental picture.
- Fundamentals in particular make the stock a compelling buy.
- The company is very cheap on a PEG basis, especially if earnings growth materializes as I think it will.
Introduction
It's been 5 years since I last wrote for Seeking Alpha, but I'm coming out of retirement to present a compelling opportunity for investment, both in general and how it applies to specific stocks. For years, I've been a curmudgeonly deep value investor who looked for low Price-to-Earnings (P/E) ratios and not much else.
Unfortunately, this eliminates most of the market these days, with ebullient sentiment inflating most of the market, especially the Magnificent Seven (Apple (AAPL), Amazon (AMZN), Microsoft (MSFT), Alphabet (GOOG) (GOOGL), Tesla (TSLA), NVIDIA (NVDA), and Meta Platforms (META) ) that have been leading the charge higher. Worse, this archaic strategy has also gotten me stuck in some value traps like 3M ( MMM ), Gilead ( GILD ), and TEVA ( TEVA ).
This has made me realize I have to adapt my strategy to fit today's manic market. However, this doesn't mean wholeheartedly hopping on the momentum train. Rather, I'm inclined to inject a modicum of growth into my stodgy strategy. Some of you have no doubt guessed where I'm going with this, which is the blindingly obvious solution of the PEG ratio.
Thesis
The PEG ratio starts with the P/E ratio but injects a Growth element into the denominator, which makes it really the Price divided by Earnings times Growth, hence PEG. Traditionally, the 5-year average earnings growth rate is used, but anyone who tells you they can predict 5 years out on Wall Street is a fool and/or charlatan. So I simply use next year's expected earnings divided by the current year's earnings (minus 1 to get growth rate, times 100 to get percent).
Stock Selection
With this criterion in mind, I searched the stock market to find companies that fit the bill. I was delighted to see one of the first to pop up was one I already own: Under Armour (UA)(UAA). It may be noted that this company has different share classes. UA is the class C shares, which carry no voting rights, and UAA is the class A shares, with voting privileges. However, there are also supermajority class B shares, which give UA founder Kevin Plank control no matter how many A shares are accumulated. For this reason, I have preferred buying the class C shares since they trade at a discount.
Regardless of share structure, this company might not be anyone's idea of a growth or momentum stock, being down around 18% so far this year. Having owned it over this period, I can tell you it has indeed felt like the stock has done nothing but go down.
Technical Analysis
However, I see subtle signs that the stock may be turning around. First off, Under Armour has recently put in a solid bottom around $6.00 on the UA chart.
Now, I'm not much of a technician (voodoo comes to mind every time I try charting), but I believe it could be valuable here on a stock that has trended down so unrelentingly. So far this year since a high in February, it has done nothing but put in a series of lower lows all the way down.
Other than a few half-hearted bounces off the $6.50 level, there haven't been many positives until last week, when the stock rallied hard along with the rest of the market, breaking out above $7, another important psychological level.
While I may be a cheapskate value investor who prefers to pay less, more technically inclined investors like to see a strong breakout like this before going long. Encouragingly, the stock again held just above the critical $6 level.
Fundamental Analysis
In addition, I think this time Under Armour is more fully supported by fundamentals as well. The company recently reported earnings ( 10Q ) that exceeded expectations. EPS came in at $0.24 for the quarter, beating expectations of $0.20. This represents 26% YOY growth, which is impressive operating leverage considering revenue came in only 2% higher than last year.
This revenue number was also ahead of expectations and was buoyed by the fact that gross margins increased by a whopping 260 basis points. This was "driven primarily by supply chain benefits related to lower freight expenses, partially offset by a channel mix impact related to a normalization of off-price sales."
In English, this translates roughly to "cheaper gas, but more discounting." As far as the latter continuing, inventory only increased by 6% YOY, well ahead of fears of a glut as in the past.
Moreover, inventory was down sequentially, declining by a whopping 13% from last quarter. Even considering seasonality, inventory was at levels below the last three quarters. This will necessitate fewer sales, of the discounting variety.
Overall sales are still expected to decrease by 2 to 4 percent . However, this is expected to be offset by gross margins continuing to rise, up another "100 to 125 basis points vs. the previous outlook of up 25 to 75 basis points." This augers well for a continued increase in earnings, with EPS now expected to be between $0.47 to $0.51, which could again beat expectations of 49 cents.
The company has been consistently beating earnings estimates for the past few quarters, and even at the midpoint of this year's trough earnings, the P/E ratio is a palatable 15, which is still fairly cheap for a company that will probably begin showing earnings growth again. Next year, EPS is expected to increase back to 60 cents.
This would be 22% earnings growth, putting the stock's valuation at a very cheap PEG of only 0.7. Also, revenue has been showing surprising strength for some time since bottoming in 2020. This would continue a pattern of annual revenue growth going back to this time.
This is a growth rate of almost 10% annualized over four years, much higher than Under Armour typically gets credit for. Notably, after a brief decline to $5.77B in 2024, the company is also projected to return to revenue growth in 2025, growing over 4% to above $6B for the first time.
If margins continue to expand, they could drive even stronger earnings growth going forward. At the $6B revenue level with the gross margins of 50% the company is driving towards, this would equate to $3B in gross profit. If current operating expenses stay flat (which they have for the past 3 years) at $2.37B, this would be an operating income of $630M, above any level they have ever put up.
This again demonstrates the awesome operating leverage they can enjoy if they just continue to increase revenue and margins. However, for the last couple of years, Under Armour has enjoyed negligible interest expenses and negative Income Tax Expenses due to tax carry forward losses from 2020.
This brought Net Income up to $410M in the latest TTM. Dividing by the 455.5M diluted shares outstanding yields 90 cents in Diluted EPS. Adjusting for both share classes, in Normalized EPS terms this equates to 45 cents.
We can't count on negative taxes forever, so we can instead subtract $95M (15% minimum corporate tax rate) and still end up with $535M in Net Income. Again, adjusting for the 900M total shares outstanding, we get 60 cents, which agrees with earnings estimates for next year. This would be 22% growth over the current estimate of 49 cents, again yielding a PEG ratio of only 0.7.
Risks
Finally, even though rates have abated (for now), investors have been concerned about debt levels for when companies, especially small caps, have to refinance their debt. However, we have seen that Under Armour has a relatively small (just under $1.5B) amount of debt and a healthy debt-to-equity ratio of 0.7.
Contrast this with other manufacturing companies like Hanesbrands ( HBI ), V.F. Corporation ( VFC ), or even NIKE ( NKE ), which are at higher ratios of 14.7, 3.5, and 0.9, respectively. However, there is the risk that this ratio could increase to levels commensurate to the competition if the company needs to borrow more to support growth initiatives.
There is also the risk that these growth drivers don't materialize, which could leave revenues and earnings stagnating. In this case, with flat earnings, we might expect the stock to go back to trading at a depressed P/E ratio of around 10, which could put the value around $5.00. However, technical and fundamental reasons should prevent it from trading down to that level anytime soon.
Valuation
With earnings power conservatively calculated to approach $0.60, at the current share price we get a very nice P/E ratio of only 12, along with a continued double-digit earnings growth rate, which should be good for a sub-1 PEG ratio. Therefore, I think UA is undervalued and worth a speculative buy at these levels. If earnings growth materializes like I think it will, Under Armour will stay a very attractive opportunity to compound wealth, especially with a buyback juicing EPS numbers.
Under Armour itself seems to agree, having repurchased $50 million of its Class C common stock during the second quarter, reflecting 7.6 million shares retired. As of September 30, 2023, 42.5 million shares for $475 million had been repurchased under its two-year, $500 million program, which the Board of Directors approved in February 2022.
Conclusion
In addition to these growth drivers, I haven't even gotten into UA's success with sponsorships, having signed football legend Tom Brady, major-winning golfer Jordan Spieth, baseball bad boy Bryce Harper, and of course Splash Brother Steph Curry, Under Armour's most recognizable spokesman. This stable of successful athletes raises brand awareness, which will lead to the recognition and retention of repeat customers.
My (9-year-old) son and his friends worship athletes like Curry and predominantly wear UA gear, even more so than Nike. Under Armour also recently partnered with another legend, (Cal) Ripken Baseball to promote the game, especially with young players. I think this young and growing cohort of Under Armour fans will continue to drive the brand forward into the future, paying off for investors who follow me into the name.
Stay tuned for new articles on other companies that meet my PEG criterion for growing earnings and thus compounding wealth. I think this strategy balances growth and value and should work well even in this crazy market. It's great to be back writing on Seeking Alpha and I look forward to the usual illuminating conversation in the comments below.
For further details see:
Under Armour: Undervalued And Finally Turning Around