Solid 1Q From UA, as expected. But in-line with our concerns from yesterday, we wonder if it is enough of a beat for a $78 stock? Our sense is that the answer is No. Working capital change here is absolutely critical. It’s a key stock driver and is eroding at the fastest rate in 13 quarters.
What we liked:
- This stock needed a beat on a big revenue number. It got it.
- UA posted +34% growth in a ‘maturing’ US apparel business. New charged cotton business shipped during the quarter and likely contributed more than we modeled. The acceleration on the underlying 2-year run rate is material.
- Nixing out all the noise behind guidance vs. so-called expectations, the absolute earnings algorithm is exceptional. +36% top line translated into +56% EBIT into +65% EPS. Not many others out there printing those numbers.
- UA took up guidance – by MORE than the 1Q beat – so early in the year speaks to confidence in 2H numbers.
What we did not like:
- Of the $0.04 beat, $0.02 is given back in 2Q due to the shift in marketing. So net/net, we’re looking at a $0.02 beat here – which is not huge relative to $78 worth of expectations.
- Inventories up +68% versus sales +36%. Check out the SIGMA. 24.5 days increase in inventory on hand is the greatest swing we’ve seen since 4Q07 (yes, 13 quarters ago). Days Receivable were up for the first time in -- yes, you guessed it – 13 quarters. Unfortunately, days payable continues to decline as UA can’t (not surprisingly) push back on vendors – especially with incremental growth coming out of the cotton side of the business. This stock has historically traded on two factors – top line momentum, and working capital changes. Check out the stock from Oct ’07 through 2Q08 – either absolute or relative to the market.
- The company beat on revenue, missed Gross Margins, and made up for it on SG&A. This is a name that we never ever ever ever want to see make or beat expectations because of SG&A. There was a $2mm shift in spending from 1Q into 2Q – or about $0.02 per share – which gives us some relief. Also, let’s be fair – I don’t want to beat the company up for leveraging SG&A on a massive 36% top line growth number. If we account for the shift in marketing spend, we’re looking at 34% SG&A growth vs. 36% top line. But the bottom line is that UA has proven that they can translate marketing spend into profitable top line growth, which is a rarity in this business. Given that it is at a critical juncture in its growth right now, we need to watch this one like a hawk.
- I wouldn’t really call this one a ‘dislike’ but let’s not forget that this is the first quarter where UA has its hats and accessories business in-house instead of with a licensee. That likely accounted for about 6% boost in top line growth right there. These little items need to be considered when we’re looking at a hyper multiple stock.
The bottom line is that I still don’t see how you get paid buying the stock at $78 on $1.60 in EPS with cash flow eroding on the margin.
Putting on my ‘where could I be wrong’ hat, we’d need to get a big jolt in realizing that this company has $4 in earnings power over the next 3-years (5-years is more realistic). That’s about 20x earnings and 10x EBITDA on a 20% long term grower – without penalizing valuation due to having to wait until 2014 to see the earnings.
I think that this company will continue to do the right thing, and invest where it’s warranted in order to enhance long-term value. When it does so, the market tends to get overly punitive. That’s when I’d be more interested in getting involved. Perhaps this quarter is the event. We’ll see.
More to come, if warranted, after the call.
