UA: Crusher, But Watch the Cash

There’s very little to punish UA for here. UA is giving the bulls all they need to keep the faith that this company will double over 3-years. But cash flow is eroding on the margin. That’s caused some pain in the past. Put your risk management hats on.

 

You gotta hand it to these guys...seriously. They crushed expectations, and it was not because they set crushable guidance over lackluster performance. This thing legitamently reaccelerated its top line to 36% (and by 12,000bps sequentially on a 2-yr run rate). EBIT grew 31% and EPS by 34%. Yes folks, that’s organic. It’s not because of one of these poor quality acquisitions that are blanketing the market, FX, or stripping the cost structure clean in anticipation of being LBO’d.  UA is the real deal.   That’s not real news to us, as it was one of our top names last year. But we hopped off early on 10/26 (see our note, UA: The Gap is Gone) at about $48 – content at a 2-bagger in six months at a time when 1) the consensus estimates moved up to our level, 2) we started to see headwinds on athlete endorsement costs, and 3) UA was in the heat of launching it’s first real cotton product at a time when cotton costs were up three standard deviations from the mean. We were wrong.

 

One thing that has changed in the market, and in retail in particular, is the premium people are willing to pay for organic growth. In retail, that’s UA, URBN, LULU. Levine and I are often asked about these three in the same sentence. One thing to consider is that UA’s model is far more exportable, and can appear to a larger audience globally. Let’s face some facts, they’ve blown it thus far going international. But UA is sticking its nose into a global duopoly (Nike and Adidas) where the primary channel would love nothing more that great quality product from a high-end US brand. Also, find me anyone that would take the other side of the debate that UA could add another $400mm in footwear sales over 2-3 years on top of a billion dollar apparel business.

 

So what are our thoughts with the stock near $60? Pretty much unchanged. The company has got great product momentum, and along with Nike, Footlocker, Dick’s, Sports Authority, and Hibbett, we should see both the space and this company materially outperform into 2011. If you want to short on valuation, then be our guest. But it’s probably gonna hurt.  I heard people say “sorry, it’s too expensive for me” at $20, $30, $40, and $50. Why not $70?

 

One thing to consider is that the biggest moves in this stock over time have happened at peak/trough cash cycles. Think about it some of the BIG calls on UA in the past.

  1. When the company began to shift into more ‘loose fit’ apparel, and away from its core compression product. That meant incremental spending on R&D, marketing, but also had to manage a different working capital cycle. Having replenishment product that turns 9x at Dick’s is a lot different that selling product with more variable pricing structure at Nordstrom at a 2x turn.
  2. Remember the (now infamous) time when UA went to ICR – even though they were not on the docket to do a presentation – and leak out the incremental SG&A spend for the Superbowl?
  3. On the flip side…nearly EVERY major move higher in UA was in conjunction with working capital coming down and SG&A growth peaking, thereby fueling the top line in the subsequent 12 months. (i.e. sales up<margins<fcf).

Therein lies the Bear Case:

“Top line growth is astounding today. But the cash cycle is weakening on the margin. Growth in company stores is accelerating, which means higher capex and working capital. The company already guided to top line growth of 25-27%, which is above its long term range. Heck, maybe that means its true intention is for 30%+ growth. But otherwise why raise expectations at the very start of what is going to be one of the years in retail with more pin action than we’ve seen in a while. If operating margins OR asset turns peak and roll (like our SIGMA shows yellow flags of doing) then the other will have to accelerate just as much in the other direction in order to offset erosion in RNOA. That will be a painful day to hold UA.”

 

When we net it all out, we think that the Bull case will prevail, but certainly at a heightened level of risk relative to where this name was for most of last year. We think this is a ‘do nothing’ stock right now. What’s funny is that ‘do nothing’ is actually positive on a relative basis compared to the rest of retail.

 

 

Review of the Quarter

 

Revenue Growth: Revenue growth was impressive up +36%, but more impressive was the fact that it came from every category – including footwear.  New product introductions will continue to be the primary growth driver including the company’s new Charged Cotton shirt (end of Q1) and additional footwear introductions on top of a full year of basketball sales. Very few companies in retail can come close to posting this type of sustainable top-line growth.

 

Direct-to-Consumer: Plans are accelerating here with management now expecting to add 25 stores in 2011 up from ~20 last quarter off a base of only 54 stores. With sales per store averaging ~$5mm per annum, Direct sales have quickly become a major growth driver accounting for 10% of growth in 2010 and is likely to drive a similar if not accelerated rate in 2011 with the majority of stores entering years 2 and 3 becoming increasingly more productive.

 

Margin Pressure(s): It’s no surprise that gross margins will face increasing pressure over the next 12-months, but higher investment spending is clearly in the plan for 2011 masking the margin expansion opportunity that comes from 20%+ top-line growth near-term. As such, guidance implies 10-50bps of EBIT margin expansion in 2011, which appears optimistic if not at the expense of lower marketing spend at year end. In addition to higher sourcing and labor costs in the 2H, the company will also be challenged by mix shift as footwear continues to grow particularly in Q2 offset in part by higher DTC revenues as well.

 

Inventories: With 45% growth on a 36% increase in revenues and further growth expected in the 1H, inventory risk remains a concern near-term. While the majority of growth is due to investments in core auto replenishment inventory, the reality is that at these levels the company is at a considerable risk if sales don’t materialize as expected. It’s also worth noting that aged inventory is half the size at year end compared to last year suggesting product is more current and would be easier to liquidate if need be. 

 

 

 

UA: Crusher, But Watch the Cash - UA S 1 11

 


Another French Revolution?

"Don't be complacent," writes Hedgeye Managing Director Neil Howe. "Tectonic shifts are underway in France. Is there the prospect of the new Sixth Republic? C'est vraiment possible."

read more

Cartoon of the Day: The Trend is Your Friend

"All of the key trending macro data suggests the U.S. economy is accelerating," Hedgeye CEO Keith McCullough says.

read more

A Sneak Peek At Hedgeye's 2017 GDP Estimates

Here's an inside look at our GDP estimates versus Wall Street consensus.

read more

Cartoon of the Day: Green Thumb

So far, 64 of 498 companies in the S&P 500 have reported aggregate sales and earnings growth of 6.1% and 16.8% respectively.

read more

Europe's Battles Against Apple, Google, Innovation & Jobs

"“I am very concerned the E.U. maintains a battle against the American giants while doing everything possible to sustain so-called national champions," writes economist Daniel Lacalle. "Attacking innovation doesn’t create jobs.”

read more

An Open Letter to Pandora Management...

"Please stop leaking information to the press," writes Hedgeye Internet & Media analyst Hesham Shaaban. "You are getting in your own way, and blowing up your shareholders in the process."

read more

A 'Toxic Cocktail' Brewing for A Best Idea Short

The first quarter earnings pre-announcement today is not the end of the story for Mednax (MD). Rising labor costs and slowing volume is a toxic cocktail...

read more

Energy Stocks: Time to Buy? Here's What You Need to Know

If you're heavily-invested in Energy stocks it's been a heck of a year. Energy is the worst-performing sector in the S&P 500 year-to-date and value investors are now hunting for bargains in the oil patch. Before you buy, here's what you need to know.

read more

McCullough: ‘My 1-Minute Summary of My Institutional Meetings in NYC Yesterday’

What are even some of the smartest investors in the world missing right now?

read more

Cartoon of the Day: Political Portfolio Positioning

Leave your politics out of your portfolio.

read more

Jim Rickards Answers the Hedgeye 21

Bestselling author Jim Rickards says if he could be any animal he’d be a T-Rex. He also loves bonds and hates equities. Check out all of his answers to the Hedgeye 21.

read more

Amazon's New 'Big Idea': Ignore It At Your Own Peril

"We all see another ‘big idea’ out of Amazon (or the press making one up) just about every day," writes Retail Sector Head Brian McGough. "But whatever you do, DON’T ignore this one!"

read more