UA: The Most Bearish News Imaginable

Takeaway: We need to peel layers off the onion to find out why good managers fail in delivering results. With $UA, we think it comes down to capital.

The sell side is hot and heavy this morning in previewing UA’s quarter, which is to be released next Thursday. That officially does not matter one iota. The announcement that Gene McCarthy, head of Footwear, has resigned is one of the most bearish datapoints imaginable for UA.

As background, Gene is no joke. He was one of the people responsible for taking Brand Jordan at Nike from a $100mm shoe line to a $1bn+ brand. He was hired to revive the ailing ‘yellow boot’ business at Timberland, where he was met with early success – to the extent that CEO Jeff Schwartz invoked the Peter Principle and made him the co-President of the company instead of leaving him in charge of the urban lifestyle division where he was making serious inroads. Then Kevin Plank made what we though at the time was one of UA’s best hires yet when he hired McCarthy to run footwear.

That said, three years after the hire, despite all the hype around new products such as ‘Spine’, UA is still struggling to break above 1% market share of the US footwear market. Far less powerful sports brands are sitting at 5-7% share, and yet UA can’t pierce the 1% veil? Clearly, either McCarthy was not what we expected, or there is something structurally impaired with UA’s approach to the footwear business.

How could someone who is so good produce such weak results?

We think that the answer does not boil down to leadership, but rather capital deployment. Kevin Plank could have Phil Knight in charge of footwear and it would still not be growing at the rate necessary to win. The reason is that for UA to print outsized growth in footwear, we need a more significant working capital and SG&A commitment that would take aggregate operating margins down to the 8% range (and would take returns along with it). (Think Reebok when it was struggling to grow against Nike)

As a frame of reference, to add another $400mm in sales, the impact would be EBIT-neutral with an incremental $44mm in SG&A spending associated with growing the business. In all reality, $40-$50mm is not a lot of capital when it comes to hiring the additional staff and aligning all the design, development and marketing resources to grow into a space with such high barriers to entry. If spending steps up, which we think needs to happen, we could see the top line pick up, but EBIT stay steady.

We don’t think it’s too relevant if McCarthy left on his own accord or was pushed out. If UA’s visibility was clear he would have stayed and Plank would never let him leave. Now we’re stuck with the COO of the company running a business that perennially disappoints relative to high expectations. McCarthy was influential with his staff, and we would not be surprised to see more departures. This kind of risk profile is not what a company with UA’s multiple can afford to exhibit. We think the 4% sell-off we're seeing today is mild given the new disclosure.