UA: The Gap is Gone

Very solid quarter all around for Under Armour. 20%-22% organic growth in sales, EBIT and EPS is nothing to shake a stick at – especially when lesser consumer discretionary names without a real growth platform and risk management process are struggling to stay afloat. That said, this was not the result that a $47 stock needed. We’re taking down our 2011 EPS estimate by $0.14 to $1.56. This is likely still at the high end of where consensus will shake out. But one of the factors that kept us bulled up on this name when it was at $35 is that the Street was at $1.10 for 2011 vs. our $1.70. That gap is officially gone.


Our downward revisions are two-fold.

1)      Cotton Risk: The one factor that UA has been largely immune to – exposure to cotton – is now a risk. “Cotton is the Enemy” is the old tagline. Now there’s a big cotton-based campaign starting in 2011. Not for a minute do we question the salability of the product. UA will brand it and sell it better than almost anyone else could. But they’ve simply never had to have a meaningful process around buying and hedging cotton. This idea was on the drawing board – including researching ideal consumer price point triggers – when cotton was around $0.80/lb. Now it’s at $1.27. That's a painful change.


2)      Inventory Risk: Under Armour had a gnarly turn in the triangulation of its sales/inventory spread vs. EBIT margin in the latest quarter, and the company mentioned on the call that the spread will erode further in 4Q. High multiple stocks simply don’t go up when this happens. It’s no accident that UA’s massive tear occurred during the six quarters it had a positive spread.


UA: The Gap is Gone - UA S 10 10


There are many more details about the quarter – and most are quite positive. But those are consistent with our thoughts all along. This remains a world class brand, a great company, and (at a price) a great stock (those three things need to be evaluated separately). But we would not look at getting back involved here without a meaningful pullback.



Our Notes From The Conf Call

Clean beat $0.63 vs. $0.60 with both revenues and gross margins slightly lighter than expected with expectations more muted near-term on the margin. Full year guidance increased as expected, suggesting the additional (incremental) $20mm we expected in the Q3 pushed to Q4 and margin degradation in Q4 vs. our prior expectation and implies EPS of $0.34-$0.35 below the Street at $0.36 placing greater importance on ultimate success of basketball launch. Initial commentary on 2011 better than expected and Street estimates calling for revs and EPS up +20%-25% implying $1.48-$1.55 in EPS vs. Street at $1.40.



P&L Notables:

EPS: Beat $0.63 (clean) vs. $0.60E ($0.68 HE)

  • Reported $0.68 ($0.05) from tax benefit
  • ~$0.02 benefit from shift in media costs out to Q4


Sales Growth: +21.9%

    - Apparel: +28% growth across all businesses (mens’, women’s and youth) though lighter than we expected down

      on both 1Yr & 2Yr

  • Men's, women's and youth all growing 25%+
  • $ growth in women's equal to men's this quarter (moving towards growing women's to same size as men's)
  • Opened 5 new factory house stores; total to 50 locations, expect 54 by year end vs. 35 in 2009

    -  Footwear: -20% declined as expected, down 1Yr up on 2Yr basis

  • Expect return to growth in 2011 driven by basketball

     -  Accessories: +19% better than expected (rounding error)

     -  Licensing: +23% better than expected (rounding error)

     -  Direct-to-Consumer: +47%



  • Revs up 60% on strength of Europe and Japan
  • Japan partner to surpass $100mm in 2010 with launch of first non-cleated footwear in Q4

New Product:

  • First performance  cotton t-shirt to be introduced in spring 2011
    • Primary benefit expanding reach of customer base

GM: 50.9%; +150bps due to:

  • primarily due to lower sales returns and other reserves (+60bps)
  • more favorable year-over-year impact of liquidations and inventory reserves (+50bps)
  • higher percentage of revenue from our higher margin Direct-to-Consumer channel (+45bps)

SG&A: 33.7%; +170bps due to:

  • continued expansion of the Factory House stores as well as increased investments in product innovation and supply chain. Marketing expense for the third quarter of 2010 was 10.9% of net revenues compared with 10.5% in the prior year - increased sponsorships and
  • Reflect $2mm shift of media costs to 4Q
  • Expect marketing costs of ~12% in full year at low end of prior guidance (12%-13%)

Tax Rate: received a state tax credit and federal reserve tax credit

  • Expect full-year rate of 39.2%
  • 2011 rate of 40.5%-41%

Balance Sheet: inventories up +28% on +22% sales growth

  • Cash to $134mm; no debt on $200mm facility
  • Inventory up as safety stock increased around core programs + increased 'made for strategy' across factory house store base

CapEx: expect to come in at lower end of $35-$40mm range




Increased guidance as expected, provided incremental view on 2011 (aggressive and above Street expectations):

  • 2010 annual net revenues in the range of $1.030 billion to $1.035 billion, an increase of 20% to 21% over 2009.
  • 2010 diluted EPS in the range of $1.23 to $1.24, an increase of 34% to 35% over 2009.
    • The updated earnings outlook reflects a full year effective tax rate of approximately 39.2%.
  • 2011 Outlook: Based on current visibility, the Company expects both 2011 annual net revenues and 2011 diluted EPS to grow at the higher end of its long-term growth target of 20%-25% implies $1.48-$1.55 in EPS
  • “mportant steps include the evolution of our current ColdGear product, the introduction of our first basketball shoes this past weekend, and leading the market once again with an innovative new apparel launch in early 2011”


Implies: EPS of $0.34-$0.35, Street at $0.36

Revs up 23%-28% ($20mm-$30mm of incremental revs – about same amount short in Q3) an acceleration on both 1Yr and 2YR 

  • SG&A growth approaching 30% in Q4
    • Includes $2mm marketing cost shift from 3Q
  • Tax rate of 40.5% to 41% in 2011
  • Inventories growth to outpace revs in Q4 to increase safety stock and new product for 2011 (i.e. hats, bags, and cotton apparel)
  • GM improvement in Q4 similar to Q3 (~+150bps)
  • Revs to see small benefit from footwear in Q4

Sports Marketing Progress:

  • In keeping with Football heritage, continuing to invest in marketable assets
  • Auburn Tigers #1 in BCS, UA has 5-year deal with the team
  • New NFL endorsements in Boldin and Miles

New Benchmarks (4 areas) as UA embarks on 2011:

  • Product
    • Introduce new market in cotton
    • 5th year making footwear, think overtime footwear could lap apparel business 
    • "challenge is to invest and win outside the cleated business" with focus on growth in running and basketball
  • Story
    • Telling the story globally in UK, Japan, and first steps in China (will become more visible in coming months)
  • Service
    • 30% YTD growth in apparel positive, but not satisfied with servicing customer demand for product
  • Team
    • Will continue to add industry pros to build out the team


Gross Margin Negative Offsets:

  • Had more apparel liquidations yy in Q3 - modest impact
  • Left inventories clean will be an offset in Q4
  • Biggest drivers growth in direct business (margin enhancing) and footwear business (negative impact)
  • Cotton not a significant driver of costs (yet) - smaller as a % of revs - don't expect a negative impact in 2011

SG&A in 2011 given new investments:

  • Targeting modest SG&A leverage in 2011

Basketball Footwear:

  • No shoes shipped in Q3
  • Will take a few years to really start to see market share gains

New Cotton Product:

  • Mostly an allocation program, little bit replenishment on the cotton side
  • From a distribution perspective, no significant changes in 2011 (including cotton product)

Footwear Trends:

  • Have seen good success in outlet channel with footwear
  • Down overall given size of the running launch last year
  • Expect margin profile in 2011 similar to 2010

Reality - Opportunity in Basketball:

  • $1.3Bn market opportunity in US alone
  • Mid-single digit share would get UA to #2 player (target) = ~$60-$75mm annual sales goal

What Mgmt has learned:

  • Emphasis on youth - can't cut out key existing customers from future launches (e.g. running)

What it's doing about it:

  • Taking the time to test and build great product - not rush

Gross Margins in Footwear:

  • Pure leverage on tooling
  • Still see ~1000bps+ opportunity overtime
  • Started off with 1 partner 5-years ago, now working with 5-6 partners

Store Growth Plans:

  • Expect another 4 factory house in 4Q
  • ~20 new FH stores in 2011 more front-end loaded
  • No plans for add'l full price retail
  • Pop-up store in NYC in November

Cost Inflation:

  • Good visibility through spring-summer 2011
  • Less than 10% of apparel manufactured in China
  • Footwear realizing cost pressure

Int'l Opportunities:

  • Gaining momentum with Japanese partner growing from $35mm in 2007 to $100mm+ in 2010
  • Expect to have a shop-in-shop up in China over next several months - approaching that market conservatively
    • First full price store in 2011
  • Typically first 5-years about understanding culture and building team (Europe now at that point)
  • Int'l overall up 60% in qtr and 59% YTD
  • Overtime goal see opportunity to build int'l to 50% of revenue base

Retail Store Performance:

  • Made for strategy around 75%-95% industry average, UA well below that
  • Currently around 2x where they were last year


  • Started footwear business with 1 partner 5-years ago; now working with 6 partners - all in China
  • Recent trip to explore geographical diversification
  • Want to keep concentrated partner base






Sweden’s Riksbank Preemptively Fights Inflation

Compared to the politically compromised Fed, statements from Sweden’s Riksbank today couldn’t be more sober. In its press release the Bank summarized its move to raise the main repo rate 25 bps to 1.00% as:


The Swedish economy is growing rapidly. On the other hand, the strength of the recovery in the United States and Europe remains uncertain.  Inflationary pressures are low in Sweden, but are expected to increase as economic activity strengthens. In order to stabilize inflation close to the target of 2 per cent and attain normal levels of resource utilisation, the repo rate needs to be gradually raised. The Executive Board of the Riksbank has therefore decided to raise the repo rate 0.25 of a percentage point to 1.0 per cent. However, due to the weak developments overseas, it is not deemed that the repo rate needs to be raised so much in the coming years.


Sweden’s inflationary environment is rather tame: the Consumer Price Index (CPI) stands at +1.4% in September Y/Y and the Producer Price Index (PPI) rose only +0.4% in September month-over-month, or +2.6% Y/Y. However, the Bank notes that currency appreciation and the country’s forecast for growth of +4.8% in 2010 and +3.8% in 2011 will boost inflationary pressures in the coming quarters.


Much like the Chinese, Norwegian and Australian central banks, which have raised interest rates to curb inflation and increase the rate of personal savings for their citizenry this year, Sweden joins the club of countries proactively addressing domestic economic policy in an environment in which global growth, particularly in the US and continental Europe, slows.  


The Swedish Krona has steadily gained versus the EUR this year, up 10.2% year-to-date. We’ll be monitoring the currency as it stands to continue to benefit alongside GDP growth that should outperform most of the European continent and gradual interest rate hikes that should buoy confidence. Equally, because the Riksbank is not hostage to the EUR, we like the set-up from a monetary standpoint, should the Bank need to maneuver around slowing global demand.


Matthew Hedrick



Sweden’s Riksbank Preemptively Fights Inflation - schweden


Very strong 2011 guidance. Hope the visibility is there. 



"We continue to characterize demand for our brands as steady and solid and the strength of our third quarter results is certainly a validation of that.  Profitability momentum moving into 2011 is also quite strong with our newest vessels performing exceptionally well and our management team controlling costs very effectively. The economy is still tough, but even facing such headwinds our outlook is remarkably encouraging."

- Richard D. Fain, chairman and chief executive officer



  • 4Q2010 Guidance:
    • Net Yields: 5% constant currency or 4-5% as reported
    • NCC:  +2% as reported or +3% on a constant currency basis
    • $0.05 negative impact from operational disruptions on Pullmantur's Pacific Dream and the Celebrity Century
  • 2011 Guidance:
    • "Expects full year 2011 Net Yields to increase by a similar proportion to 2010"
    • "Expects that the most meaningful yield recovery in 2011 will occur correspondingly during those same two summer quarters"
    • 1Q2011 Net Yields: +2-4%
    • FY2011 EPS: $3.26


  • Bulk of their improvement is coming from their new ships and improvement in marketing of their existing ships
  • Early patterns for next year are very encouraging
  • Should have meaningful positive cash flow
  • Despite Europe being strong, Spain and Pullmantur have not been great. Have assumed that the malaise in the Spanish economy continues for the foreseeable future
  • 3Q result commentary:
    • Alaska and the Caribbean showed the most improvement and Europe was strong as well
    • Yields in the 3Q were still 12% below peak
  • Booking environment:
    • Load factors are ahead for 4Q and all 4 quarters for 2011
    • Customer deposits are running 26% ahead of last year
    • Developmental itineraries are showing the most improvement
  • 2011 Guidance:
    • 1Q bookings are up to a solid start
    • Are starting to see some cost pressures especially on food costs
    • Expect to meet 2011 maturities with cash from operations
  • Royal Caribbean International brand:
    • Initial revenue cruise for Allure of the Seas will be Dec 1
    • Oasis or Freedom class will account for over 33% of RCL's capacity
  • For the first time in history they will sail with more European than American guests on their European brands


  • Guest mix development overtime?
    • Mix is trending more towards guests coming more from outside of the United States
    • The majority is still from the US but it's getting close to 50/50
    • Europe is the clear majority of their non-US mix
  • The onboard and other decline was driven by the tour division. Onboard revenues was flattish. Customers on their developmental itineraries also tend to spend less onboard
  • They are not assuming a large uptick in onboard spending
  • They are going more for profit rather than volume at Pullmantur's tour division
  • Saw good rate demand both from European demand (75% of the demand for European ships) and from US demand - despite rising airfare
  • Forward booking patterns give them reasonable confidence that Europe can absorb the large increase in capacity
  • Don't expect to do any more Oasis class ships but they will have future growth - rate of growth has slowed and will be slower than it has been historically. Right now, they are focused on generating growth from improved yields and margins. Don't expect to add any new ships until 2014.
  • Capacity mix will be similar to 2010 next year with Europe growing faster
  • How much of the net yield increase is due to same store pricing vs. mix factors and new ships?
    • Have a little more than 1/3 of their business on the books for next year
    • Investors are very focused on 2011
    • They continue to benefit from new vessels
    • Roughly 50% of the increase in yields that they expect for next year comes from new ships
  • Very high % of their business is on the books already for 4Q
  • Being 1/3 booked for 2011 is better than the last few years but lower than peak years. Booking curve is 4.5 months.
  • There are new regulations regarding emissions coming online; they will bake those costs into their forecast. No surprises though.
  • Is bringing back the dividend a priority/possibility for 2011?
    • It will be up to the board but even at the peak the dividend wasn't that material to their deleveraging plans
  • Examples of cost programs
    • Changed supply management team
    • Marine departments- put a virtual inventory management program in place
  • 26% increase in customer deposits is a combination of additional capacity, higher load factors and increased pricing
  • Don't see nearly as much volatility as a result of the stock market on their results.  Seems like a much more linear recovery than last time around.
  • Hedges are at prices below current spot fuel prices
  • Too early to give cost guidance for 2011

FL: Sales Upside Increasingly Likely

It’s becoming more apparent that our forecast of a 4.5% same store sales increase for Foot Locker’s 3Q may be conservative.  When we use our proprietary index of NPD and Sportscan weekly data to predict the trend, we now believe we could be understating the results by about 100 bps. 


The chart below speaks for itself. The yellow line is reported FL same store sales (global).  The White and Magenta lines are weekly trends we track via Sportscan and NPD.   White is a blended mix including an 88% weight of NPD footwear and 12% Sportscan athletic apparel.  Magenta is 100% domestic footwear.  Blue is 100% domestic athletic apparel.  We can’t explain with 100% confidence why the domestic scan data matches up so well with FL global comps, but it does.  Over the past 12 quarters, 50% of actual results have been within 100bps of the predicted outcome.  The remaining quarters have hovered between a 100-400bps range of actual results. 


With positive anecdotal evidence in addition to the chart below, it is becoming increasingly likely that we’re setting up for a 5-6% comp at FL.   We remain above the Street at $0.20 for the quarter but believe this could also be conservative given the relatively benign level of promotional activity we’ve observed.  In fact it appears that BOGO may have been wiped from the FL lexicon (at least for the near-term).   Foot Locker remains one of our favorite long ideas.


FL: Sales Upside Increasingly Likely - FL Q3 Comp read 10 25 10


*Note: Our index is compiled from weekly data reported on Wednesdays, based on a reporting period through the prior week ending on Sunday.  The chart above tracks trends through 10/17/10. 


Eric Levine


Japan’s Jugular Continues… Don’t Buy the Hope

Conclusion: Simply put, the broad slowdown within the Japanese economy continues. Don’t buy the hope associated with oncoming yen weakness or hopeful expectations of an economic recovery in the U.S.


Position: Short Japanese equities; Short the Japanese yen.


Per our 4Q10 Macro Themes presentation, the summary of our intermediate-term investment thesis on Japan reads: “Japan’s export-led recovery slows to a halt in 4Q10. GDP could potentially go negative in the next two quarters.”


With the inclusion of Japan’s latest trade data which was released over the weekend, we feel comfortable saying sufficient “progress” towards negative GDP growth in the island economy is being made. Japanese export growth slowed again sequentially in September to the slowest growth since December 2009, coming in at +14.4% YoY. That number was posted against a (-30.6%) “comp” and October 2009 represents the last of the easy “comps” at (-23.3%). The mathematical headwinds get increasingly difficult in November and December of 2009, at (-6.3%) and +12.1% YoY.


Japan’s Jugular Continues… Don’t Buy the Hope - 1


Sell-side analysts and the media alike have gotten the bear case to-date, which is largely driven by the strong yen – which has been trading at or around a 15-year high versus the dollar over the past several weeks. As we have shown in our presentation (email if you need the replay materials) Japan’s economy is leveraged to manufacturing and exports, which are the key sources for employment and investment within Japan.


As we called out back in August, the strong yen is a major headwind for Japanese exporter’s competiveness and profit margins, which, in turn, are negative for the Japanese economy. Per Japan’s Cabinet Office latest annual survey, Japanese companies remain profitable as long as the yen trades at 92.90 per dollar or weaker in FY11, which began on April 1st for many companies. To date, it has averaged around 88 per dollar, despite recent Japanese Bureaucrat efforts to weaken the yen, which have included Comprehensive Monetary Easing and intervention in the FX market (the latter of which has been marginalized due to increasing global opposition to currency devaluation).


Japan’s Jugular Continues… Don’t Buy the Hope - 2


As we’ve said all along, the #1 factor driving yen appreciation is dollar depreciation, i.e. it isn’t that the yen is going up as much as it is the dollar is going down (down -13% since its June 7 high). What could cause the dollar to reverse its decline over the intermediate term and “alleviate” the stresses on the minds of many Japanese manufacturers? The three factors we see as most likely in our models are: 

  1. Hawkish fiscal rhetoric from a more Republican Congress (see Boehner’s recent comments on spending cuts)
  2. Mean reversion
  3. Widespread reflexive declines in emerging market equities and commodities (triggered by tightening in China and the QE2 announcement “missing” lofty expectations); global loss aversion should increase demand for cash holdings 

Of course, when the yen starts to go down, you’ll get your fair share of lemmings touting Japanese stocks because currency headwinds will shift on the margin to currency tailwinds. Don’t buy the hope. Growth in the U.S. (Japan’s second-largest export market) is setup to slow meaningfully over the next 2-3 quarters and I’m willing to bet the family business that anyone telling you to buy Japanese stocks in the next 3-6 months doesn’t see the Consumption Cannonball coming. Layer on tightening in China (Japan’s largest export market) coupled with rising tensions between the Asian rivals, and it looks increasingly like Japan is running out of bullets over the intermediate term.


Overnight, Japanese Prime Minister Naoto Kan’s Cabinet approved a 5.1 TRILLION yen ($63 billion) stimulus package on top of an additional 1.5 TRILLION yen special account available to the Japan Bank for International Cooperation for overseas investment and infrastructure projects. As the chart below clearly shows, this too won’t matter when it’s all said and done. Again, don’t buy the hope.


Darius Dale



Japan’s Jugular Continues… Don’t Buy the Hope - 3


Conclusion:  Many shorts were squeezed by the better-than-expected top line results from earnings thus far.  Watch out for high short interest names and the risk of results surprising to the upside (or being less bad than expected).


Short interest has been building in a selection of names over the past couple of months (of reported short interest data) with PFCB, CMG, DPZ, PNRA, and BWLD being the most notable in both their respective increases in, and absolute levels of, short interest.  PFCB is reporting tomorrow and the street seems convinced that management’s assertion in July that the company stands a “reasonable chance” of achieving roughly $2 in earnings is slightly over-stretched.  There are several reasons why being short the stock ahead of earnings could be ill-advised.  Firstly, Knapp-track data and recent earnings results are showing buoyant top-line trends in the restaurant space.  Regarding PFCB specifically, management expressed confidence that the EPS target of $2 would hinge largely on top line momentum established in 1H10 continuing into the back half.  While my initial reaction to this target was one of skepticism, recent industry data and peer earnings results suggest that – absent significant market share loss – PFCB could be closer to achieving its target than the street thinks. 


CMG is a very different concept than PFCB and is at a different stage of their business development but their recent earnings caught many – myself included – by surprise.  One only needs to look at the surge in short interest over the last two months to realize that.  While there is a cogent short thesis on CMG, timing is everything and the squeeze on Friday underlined this fact.  Other names that I see as being dangerous to be standing in front of are JACK and PEET.  Both names are heavily shorted and trends around their respective categories have been less bad of late.   I believe BWLD will post a good quarter later today on the back of favorable commodity costs and also overall strong industry sales trends.  With the exception of the most recent two weeks reported, short interest has been building significantly in that name. 


SHORT INTEREST DATA - short interest 1025


Howard Penney

Managing Director

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