UA's beat was in line with our comments from earlier this week that revenue trends were looking strong, and the favorable spread between sell-in and sell-though on top of a lean inventory base headed into the quarter suggested a favorable gross margin set-up (see comments below). Lo and behold, UA came out and beat on revenue and printed its biggest gross margin improvement in three years. Simply put, UA continues to achieve its growth goals with impressive consistency. We've got to give credit where it's due.
Despite the solid numbers, there were a few things that bugged us.
1) Inventories were high -- +29% vs revenue growth of 23%. This reverses the positive sales/inventory trend we've seen for the past three quarters. Granted, it is consistent with the company's guidance that inventories would build to ensure that they have sufficient product headed into back-to-school and Holiday. But the dynamic is notable.
2) With all the talk about International opportunity on the conference call, you'd think that UA was knocking the cover off the ball outside the US. Yes, sales were respectable at 22%, but it grew modestly below the rate of the US business. UA made it clear that 2014 would be the year for Int'l to really accelerate. But the reality is that UA's Int'l success is kind of like Bigfoot -- lots of hype, but we have yet to actually see it.
3) Footwear surprised us on the downside. While 21% growth is respectable, we think it should be at least 2x that rate for a company with UA's growth runway. On one hand, we like that it is being very deliberate and cautious with the launch of Speedform -- and not flooding the market with product. But we balance that with the simple fact that UA has 1% share of an industry that is absolutely begging for someone to step up and become a viable alternative to Nike.
When all is said and done, we like the TAIL call on UA -- as there are not many companies that we think can grow top line in excess of 20% for 5+ years. On the flip side, this is absolutely not a margin story. What you get in top line is what you get in EPS growth. That's all, and nothing else. That's not half bad given that the company can feasably triple in size. But there are other names like RH, FNP, (and to a lesser extent) WWW that have similar Blue Sky opportunity but with significant margin and return upside as a kicker. We can justify the higher multiples with those stories more easily than with UA. We'd prefer to step in and buy UA when there's more controversy on the name, or when the company is hitting a near-term speed bump in one of its new business initiatives. That's certainly not what we have today.
UA: OUR THOUGHTS HEADED INTO THE PRINT
Takeaway: Expectations aren't low into UA's print, but based on trends we're seeing, they shouldn't be. If we were forced to bet, it'd be positive.
CONCLUSION: UnderArmour footwear and apparel trends look solid headed into Thursday's print, especially in comparing wholesale sell-in versus retail sell-through. Retail inventory implications are bullish, and combined with a positive sales/inventory spread trend at UA, it's left with a particularly positive Gross Margin set-up. That's a big plus, because at 35x EPS it needs to beat, and expectations aren't low. If we had to make a bet one way or another (which we don't), we'd come out with an upwards bias.
We think that UA's trends look quite positive headed into its print on Thursday. Our analysis shows that a) sell-through of apparel continues to outstrip sell-in, b) footwear is doing so at even a greater rate (and the Speedform launch is gaining traction), and c) the Gross Margin set-up is bullish given easing product costs and a favorable sales/inventory spread. All that said, we think that these trends are necessary to materially beat consensus estimates (a beat is critical for a 35x p/e growth stock). The good news is that our sentiment monitor suggests that this name remains extremely hated, which is a bullish stock setup.
One of the few risks we'd point to is if UA comes out and takes up SG&A requirements to grow the business as initiatives into Footwear and International markets become more important. This had been a concern of ours for a while, but after the company's analyst meeting last month we threw in the towel and altered our view (and our model) such that it could attain 20% top line growth without having to take the margin levels of the company sub-10%. But if it nudges up spending rates again after just having the investment community in Baltimore to sell its strategy -- then there are going to be credibility issues. We'd be surprised if this turns out to be the case.
So when we put it all together, we think that this is one of times where the consensus has it about right, but if we had to make a bet one way or another (which we don't), we'd have an upward bias.
UNDERARMOUR'S APPAREL RETAIL SALES HAVE BEEN GROWING AT A RATE FASTER THAN ITS WHOLESALE SELL-IN
Source: SportscanINFO and Hedgeye
UNDERARMOUR'S FOOTWEAR BUSINESS HAS BEEN OUTSTANDING -- AGAIN, WITH RETAIL OUTSTRIPPING WHOLESALE
Source: NPD and Hedgeye
SPEEDFORM HAS BEEN A RECENT DRIVER FOR THE FOOTWEAR BUSINESS. THIS IS THE MOST COMMERCIAL LAUNCH UA HAS HAD TO DATE
THE GROSS MARGIN SET-UP IS SOLID THANKS TO AND EXTREMELY FAVORABLE SALES/INVENTORY SPREAD AND FAVORABLE PRODUCT COSTS
Source: Company Reports and Hedgeye
OUR SENTIMENT MONITOR SHOWS THAT THIS STOCK REMAINS VERY HATED