UA: The Duration Bifurcation

The BIG call is that sales/EPS will double over 3 yrs. No one owns it for blow-out EPS today, and nothing will come out of 2Q to either rattle the long-term call, or to make the 28% of float that is already short press its bet. My sense is that a beat will boost the stock more than a miss would hurt, and 2H call options are under appreciated. I remain positive.

 

Negative sentiment is building again on UA in advance of earnings. Duration is a major factor here - perhaps more so than with any story I can find. Why?

 

Core apparel sales are flattish, footwear is performing 'fine' (i.e. not stellar), management has been selling stock, key internal positions have turned over, prior guidance is vague, 2Q just closed after it rained for 80% of the most important month of the quarter, and at 26x earnings it is one of the most expensive stocks in retail.  I never ignore the facts, and they're particularly important when the stock is resting right on top of $21 TREND support in Keith's model.  I can't say that I blame the bears...

 

So how in the world could anyone justify being bullish? Well first off, the simple fact that this question is being asked is notable.

 

But there is a massively more important consideration... NO ONE who owns UA does so because they think that the company will smoke the upcoming quarter or year. It's generally accepted - and probably correct - that UA will print somewhere in the ballpark of $175mm in footwear sales this year, and that apparel revenue will be flat-to-down organically.

 

Is that worth 26x earnings and 11 EBITDA? Probably not -- unless you're banking on meaningful growth in the business in the next 3 years. Here's the key... The question as to whether this will happen will absolutely not be proved or disproved by 2Q results or guidance.

 

  • Regardless as to whether footwear sales/guidance are +/- $25mm for the year, this says little as to whether UA will succeed or fail in getting footwear market share from >1% to 5% (around $500mm in added sales) over 3 years. Bulls are unlikely to throw in the towel unless the company does. UA will definitely not back off this strategy, and in fact is likely to highlight organizational changes to take the footwear organization to the next level.

 

  • Similarly, for someone on the short side that is banking on a miss and/or weak 2H top line guidance, the rebuttal is likely to be that orders for fall were placed at a time retailers were choking on product due to weather-impacted comps. I rarely give that free pass, but this is one instance where it's pretty much a no-brainer.

 

Let's remember that only 14% of analysts have a 'Buy' rating on UA (lowest in history) and the average price target is 6% below current levels. Short interest as a percent of float has stepped up from 23% to 28% over the last three months.

UA: The Duration Bifurcation - 7 8 2009 7 19 14 AM

 

So it sounds to me like this is going to hinge upon a meaningful negative earnings revision to beat it down. In going through our model, I've got revenue growing about 5% better than consensus for the remainder of the year. Margins are more of a question mark. But keep in mind that we are anniversarying the launch of cross training - which had a negative impact on mix and margins.

 

Also, starting in 2H there will be a notable favorable change in capacity for footwear production (and prices) in China, which should ease margin compares. Let's also not forget the Foot Locker factor. Brand new CEO coming from JC Penney where he was President and head of merchandising. Every vendor was at his mercy. Now he comes in to a smaller box where one vendor accounts for over 50% of sales. Not a good setup... His first move will be to sit down with every vendor and find ways to optimize his shoe wall. That means more Under Armour as FL will want to be in the pole position for driving starting a partnership not unlike what DKS and UA had in apparel off-mall. I can't imagine that these are consensus ideas.

 

The bottom line is that we get to UA beating the quarter by a couple pennies, and earning $0.88 for this year in both EPS and FCF/share, and then $1.10 and $1.35 in 2010 and 2011, respectively. A mid-teens grower this year and 20-25% the two years thereafter? Yeah, I'll stomach a multiple starting with a 2-handle for that. Mind you, this is $1.2bn in revs which only represents 3% share of the relevant footwear market (Adi is 6%, Reebok = 4%, Puma = 3%, Asics and New Balance range between 6-8%).  It also assumes very little success driving a women's business and International presence.

 

As for the quarter, when I add up all the puts and takes on sentiment, my sense is that a beat (or any bit of positive news) will disproportionately boost the stock as opposed to how much a miss would hurt.


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