prev

UA – KILLER GROWTH IS GETTING COSTLY

Takeaway: What’s hotter, Brand or cost structure? At some point, EPS has to grow. It will, but at 15x a best case EBITDA # 5-yrs out, timing matters.

Every headline out there today will talk about how UA is simply killing it – and it’s well-deserved. UA’s brand heat continues to roll full steam ahead, and the company is proving itself out to be one of the true generational growth stories in Consumer.

 

That said, we think it's more than fair to point out that Revenue growth is accelerating, but earnings growth is decelerating. In fact, this company has not grown earnings since 4Q14. When 2015 is said and done, we’re likely to see revenue, EBIT and EPS grow at 25%, 15%, and 10%, respectively. That’s not the kind of ‘World Class’ growth algorithm that we’d expect from a World Class Brand like UA.

 

We understand that the company is investing today in order to capitalize on (and create outright) growth opportunities tomorrow. We like when companies play offense like that. But at 75x earnings and 36x EBITDA, is it too much for us to expect that earnings grow faster than Wal-Mart? We don’t think so.

 

We’ve always said that the cost of growth in this space is headed higher. In fact, UA was fairly explicit on its call in saying that it would capitalize on brand heat in 2H by spending more on athletes and endorsements. While that makes sense academically, and probably financially if executed right (which UA probably will) the reality is that Nike will make this very difficult.

 

Keep in mind that this is the first time Nike and UA will truly be going toe to toe in a meaningful way since UA came along and created a space (compression apparel) that Nike arguably had the technology for first – but failed sorely to execute on. We got a little taste of the endorsement battle with Kevin Durant, which UA fortuitously lost to Nike to the tune of ~$30mm/yr.

 

As a point of reference, Durant represented 33% of UA’s existing endorsement obligations this year, but only 3% for Nike. UA ‘lost’ Durant, but stuck it to Nike with Spieth, Copeland, Curry. In other words…Nike is not happy right now. NKE’s Sports Marketing group is feeling heat it has not felt in over a decade. Do you think that just MAYBE Nike is going to step up its marketing spend by a couple hundred million to secure its dominance? You betcha.

 

UA – KILLER GROWTH IS GETTING COSTLY - ua endorsement

 

We’re not saying that Nike will secure dominance – we’re just saying that it is going to spend in its attempt to get there. Also keep in mind it has a brand new CFO who comes from the brand side of the house, who is more likely than Don Blair (one of the best CFOs we’ve seen in all of Consumer Discretionary in 23 years) to rubber stamp spending that might be ROIC dilutive.    

 

The bottom line on the stock is that as much as we like the multi-year top line growth potential, we’re reasonably certain that it will come at the expense of margins and ROIC. But that’s hardly a reason for us to be short a name that’s earned its spot as the clear #2 player in a global oligopoly where retailers are begging for an alternative to Nike. But even if we assume that UA continues to grow mid to high 20% EVERY year for five years resulting in $9bn in sales, AND overcomes near-term margin pressures and pops back up to 12% EBIT margins, we get to an even $3.00 in earnings. That’s a 32.5x p/e and 15.5x EBITDA multiple on a number 5-years out that takes a whole lot of positive assumptions to get to. We’re simply going to sit back until the research call suggests a more asymmetric setup – in either direction.

 

SOME HIGHLIGHTS FROM THE CALL

1) Top line continues to look very very strong accelerating on a 2yr basis. Int'l and footwear (the two categories where UA is still establishing a beachhead) ticked up on a 2yr basis and now both account for over 10% of revenue. The guidance raise of $60mm after a $20mm beat with no lift to margin dollars was enough for the bulls to get excited about.

 

UA – KILLER GROWTH IS GETTING COSTLY - UA footwear intl

 

2) On the margin front -- the company cited  gross margin pressure from Fx, connected fitness dilution, and extra air freight cost for the 160bps whack in op margins, but that doesn’t explain the 70bps decline in the NA business. Brand Houses (ie the 30,000 sq. ft. store on Michigan Ave in Chicago) are significantly more expensive on a unit basis then the legacy Outlet locations, but we'd expect a little more leverage on 22% revenue growth in its biggest region.

3) The athletic footwear and apparel market in the US had a monster 2Q. NKE and UA grew at 13% and 22% respectively totaling $560mm in revenue. That’s good for at least 3 points of growth for the entire athletic footwear and apparel market alone which did about $16.75bil in LY's 2Q. DTC at UA kicked it up in a big way growing 33% in the quarter -- up 1200bps sequentially on the 1yr and 700bps on the 2yr trend line.

4) As noted above the investment cycle is no where near close to being over. On the call management talked a number of times about the fact that fulfillment rates and global infrastructure is not anywhere close to where it needs to be as evidenced by the 50bps hit or $4mm in incremental air freight expense during the quarter. That makes sense given the fact that Int'l penetration has grown by 5 percentage points on a TTM basis over the past 18 months. There is a lot of track that needs to be built in order to support this global network.

5) The last piece of the puzzle is the company's move to a sports/category focused org. structure rather than the simple 2 dimensional structure that exists today. UA has been hiring leadership talent to facilitate this transition, but if we use Nike as the model when it switched to the category offense -- we are looking at least 3 years of growing pains before the model is optimized – and that’s if it executes perfectly.  Given UA’s impressive execution track record, management will probably get it right by hiring all the right people into the appropriate roles. But this takes time.  


UA – Killer Growth is Getting Costly

Takeaway: What’s hotter, Brand or cost structure? At some point, EPS has to grow. It will, but at 15x a best case EBITDA # 5-yrs out, timing matters.

Every headline out there today will talk about how UA is simply killing it – and it’s well-deserved. UA’s brand heat continues to roll full steam ahead, and the company is proving itself out to be one of the true generational growth stories in Consumer.

 

That said, we think it's more than fair to point out that Revenue growth is accelerating, but earnings growth is decelerating. In fact, this company has not grown earnings since 4Q14. When 2015 is said and done, we’re likely to see revenue, EBIT and EPS grow at 25%, 15%, and 10%, respectively. That’s not the kind of ‘World Class’ growth algorithm that we’d expect from a World Class Brand like UA.

 

We understand that the company is investing today in order to capitalize on (and create outright) growth opportunities tomorrow. We like when companies play offense like that. But at 75x earnings and 36x EBITDA, is it too much for us to expect that earnings grow faster than Wal-Mart? We don’t think so.

 

We’ve always said that the cost of growth in this space is headed higher. In fact, UA was fairly explicit on its call in saying that it would capitalize on brand heat in 2H by spending more on athletes and endorsements. While that makes sense academically, and probably financially if executed right (which UA probably will) the reality is that Nike will make this very difficult.

 

Keep in mind that this is the first time Nike and UA will truly be going toe to toe in a meaningful way since UA came along and created a space (compression apparel) that Nike arguably had the technology for first – but failed sorely to execute on. We got a little taste of the endorsement battle with Kevin Durant, which UA fortuitously lost to Nike to the tune of ~$30mm/yr.

 

As a point of reference, Durant represented 33% of UA’s existing endorsement obligations this year, but only 3% for Nike. UA ‘lost’ Durant, but stuck it to Nike with Spieth, Copeland, Curry. In other words…Nike is not happy right now. NKE’s Sports Marketing group is feeling heat it has not felt in over a decade. Do you think that just MAYBE Nike is going to step up its marketing spend by a couple hundred million to secure its dominance? You betcha.

 

UA – Killer Growth is Getting Costly - ua endorsement

 

We’re not saying that Nike will secure dominance – we’re just saying that it is going to spend in its attempt to get there. Also keep in mind it has a brand new CFO who comes from the brand side of the house, who is more likely than Don Blair (one of the best CFOs we’ve seen in all of Consumer Discretionary in 23 years) to rubber stamp spending that might be ROIC dilutive.     

 

The bottom line on the stock is that as much as we like the multi-year top line growth potential, we’re reasonably certain that it will come at the expense of margins and ROIC. But that’s hardly a reason for us to be short a name that’s earned its spot as the clear #2 player in a global oligopoly where retailers are begging for an alternative to Nike. But even if we assume that UA continues to grow mid to high 20% EVERY year for five years resulting in $9bn in sales, AND overcomes near-term margin pressures and pops back up to 12% EBIT margins, we get to an even $3.00 in earnings. That’s a 32.5x p/e and 15.5x EBITDA multiple on a number 5-years out that takes a whole lot of positive assumptions to get to. We’re simply going to sit back until the research call suggests a more asymmetric setup – in either direction.

 

SOME HIGHLIGHTS FROM THE CALL

1) Top line continues to look very very strong accelerating on a 2yr basis. Int'l and footwear (the two categories where UA is still establishing a beachhead) ticked up on a 2yr basis and now both account for over 10% of revenue. The guidance raise of $60mm after a $20mm beat with no lift to margin dollars was enough for the bulls to get excited about.

UA – Killer Growth is Getting Costly - UA footwear intl

2) On the margin front -- the company cited  gross margin pressure from Fx, connected fitness dilution, and extra air freight cost for the 160bps whack in op margins, but that doesn’t explain the 70bps decline in the NA business. Brand Houses (ie the 30,000 sq. ft. store on Michigan Ave in Chicago) are significantly more expensive on a unit basis then the legacy Outlet locations, but we'd expect a little more leverage on 22% revenue growth in its biggest region.

3) The athletic footwear and apparel market in the US had a monster 2Q. NKE and UA grew at 13% and 22% respectively totaling $560mm in revenue. That’s good for at least 3 points of growth for the entire athletic footwear and apparel market alone which did about $16.75bil in LY's 2Q. DTC at UA kicked it up in a big way growing 33% in the quarter -- up 1200bps sequentially on the 1yr and 700bps on the 2yr trend line.

4) As noted above the investment cycle is no where near close to being over. On the call management talked a number of times about the fact that fulfillment rates and global infrastructure is not anywhere close to where it needs to be as evidenced by the 50bps hit or $4mm in incremental air freight expense during the quarter. That makes sense given the fact that Int'l penetration has grown by 5 percentage points on a TTM basis over the past 18 months. There is a lot of track that needs to be built in order to support this global network.

5) The last piece of the puzzle is the company's move to a sports/category focused org. structure rather than the simple 2 dimensional structure that exists today. UA has been hiring leadership talent to facilitate this transition, but if we use Nike as the model when it switched to the category offense -- we are looking at least 3 years of growing pains before the model is optimized – and that’s if it executes perfectly.  Given UA’s impressive execution track record, management will probably get it right by hiring all the right people into the appropriate roles. But this takes time.  

 


INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973?

Takeaway: SA claims just hit their lowest level since 11/24/73. The labor market faces extreme resistance against improving much further from here.

Below is the breakdown of this morning's initial claims data from Joshua Steiner and the Hedgeye Financials team. If you would like to setup a call with Josh or Jonathan or trial their research, please contact 

 

Multi-Decade Lows & Energy Re-Coupling

The chart below shows that seasonally adjusted initial claims just hit 255k, the lowest level in forty two years. The last time claims were lower was November 24, 1973, when the reading came in at 233k. While this exemplifies extreme strength in the labor market, it also represents a point of extreme resistance against claims going any lower.

 

We continue to point out that this party has an expiration date, which we estimate to be about five quarters from now. In the last three cycles, once claims dipped below 330k they remained there for 24 months, 45 months, and 31 months, in the late 1980s, late 1990s/early 2000s, and 2006-2008 period, respectively before the economy went into recession. In the current cycle, claims have been below 330k for a little more than 16 months and counting. The average of these last three cycles is 33 months, which would translate to another ~5 quarters of track.

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims20

 

While we were hesitant last week, given holiday distortion, to make a definitive statement on improving energy state claims, the improvement has sustained itself through the week ending July 11. The chart below shows that since the week ending June 27, the spread between indexed energy state claims and the country as a whole has tightened from 15 to 3. 

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims18

 

The Data

Initial jobless claims fell 26k to 255k from 281k WoW. The prior week's number was not revised. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -4k WoW to 278.5k.

 

The 4-week rolling average of NSA claims, another way of evaluating the data, was -7.8% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -9.1%

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims2

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims3

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims4

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims5

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims6

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims7

 

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 

 



Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

McCullough: Apple Is the Most Over-Owned Stock In Human History

Editor’s Note: Below is an exchange between Hedgeye CEO Keith McCullough and a reporter from London’s City A.M. who asked McCullough his thoughts on Apple, tech stocks, and whether we’re in another bubble. To read the original City A.M. article click here.

*  *  *  *  *

McCullough: Apple Is the Most Over-Owned Stock In Human History - z app

 

1. Do you think Apple and tech stocks in general are overvalued?

 

A) Apple isn’t a value stock – it’s the most over-owned stock in human history where “valuation” comes into the debate on down days. It’s actually a product-cycle stock, and all cycle stocks should look relatively “cheap” at the peak of a cycle

 

B) What Morgan Stanley calls “New Tech” trades at an average P/E of 149.5x forward earnings. Overvalued is an understatement. It’s obviously a bubble.

 

2. Is there potential for tech firms across the world to lose a lot of value?

 

Yes.

 

If/when product cycles slow, multiples compress. Most people don’t realize that advertising is a #LateCycle revenue gainer. As the economic cycle slows, advertising slows – and so will some “social tech” ad revenues.

 

3. In Europe there was a big drop across equity markets today, driven largely by tech performances - do you see this potentially continuing? Is there a risk to European and Asian tech stemming from Apple and other US stocks' performances?

 

Yes.

 

#EuropeSlowing is a Top 3 Global Macro Theme @Hedgeye right now. Consensus is confusing the political panic in Europe with the causal factor that is economic growth slowing. “Old” (or Industrial) Tech is slowing as the global cycle does.

 

4. Is this another tech bubble? Does this look like the dotcom bubble?

 

Yes (see above).

 

Across market histories, from tulips to dot.bombs, every bubble is unique. Instead of the internet, I think we’ll call this one the cloud of expectations.

*  *  *  *  *

McCullough discussing Apple with Maria Bartiromo on Fox Business. 


INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973?

Takeaway: SA claims just hit their lowest level since 11/24/73. The labor market faces extreme resistance against improving much further from here.

Multi-Decade Lows & Energy Re-Coupling

The chart below shows that seasonally adjusted initial claims just hit 255k, the lowest level in forty two years. The last time claims were lower was November 24, 1973, when the reading came in at 233k. While this exemplifies extreme strength in the labor market, it also represents a point of extreme resistance against claims going any lower. We continue to point out that this party has an expiration date, which we estimate to be about five quarters from now. In the last three cycles, once claims dipped below 330k they remained there for 24 months, 45 months, and 31 months, in the late 1980s, late 1990s/early 2000s, and 2006-2008 period, respectively before the economy went into recession. In the current cycle, claims have been below 330k for a little more than 16 months and counting. The average of these last three cycles is 33 months, which would translate to another ~5 quarters of track.

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims20

 

While we were hesitant last week, given holiday distortion, to make a definitive statement on improving energy state claims, the improvement has sustained itself through the week ending July 11. The chart below shows that since the week ending June 27, the spread between indexed energy state claims and the country as a whole has tightened from 15 to 3. 

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims18

 

The Data

Initial jobless claims fell 26k to 255k from 281k WoW. The prior week's number was not revised. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -4k WoW to 278.5k.

 

The 4-week rolling average of NSA claims, another way of evaluating the data, was -7.8% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -9.1%

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims2

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims3

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims4

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims5

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims6

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims7

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims8

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims9

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims10

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims11

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims19

 

Yield Spreads

The 2-10 spread fell -11 basis points WoW to 161 bps. 3Q15TD, the 2-10 spread is averaging 170 bps, which is higher by 12 bps relative to 2Q15.

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims15

 

INITIAL JOBLESS CLAIMS | PARTY LIKE IT'S 1973? - Claims16

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


TODAY @ 1PM ET: Internet INVESTMENT IDEAS Quarterly Call

Takeaway: Please join us for our call today at 1:00pm EDT. Dialing instructions below, and posted within the calendar invite link directly below

link: OUTLOOK CALENDAR INVITE W/ CALL DETAILS

 

We will be hosting our quarterly INTERNET INVESTMENT IDEAS Update Call today.  We will be reviewing the major themes and incremental developments to our Best Idea Short theses (YELP, P), our Short thesis on TWTR, and our Bearish thesis on BABA (covered).  The emphasis of this call will be to highlight our view over various durations as well as the upcoming catalyst calendar; identifying the major risks and catalysts to each position over the near-to-intermediate term.  In addition, we will preview our new Best Idea Long thesis on LNKD ahead of our upcoming Blackbook.

 

Please join us for our call today at 1:00pm EDT.  Dialing instruction below.

 

KEY TOPICS WILL INCLUDE

  • Review of major themes and incremental developments to our thesis on YELP, P, TWTR, and BABA.
  • Highlighting our view over various durations as well as the upcoming catalyst calendar: Risks & Catalysts to each position over the NTM.
  • We will also provide an overview of our new Best Idea Long thesis on LNKD

 

Participating Dialing Instructions

  • Toll Free:
  • Toll:
  • Confirmation Number: 13615250
  • Materials: CLICK HERE

 

 

Hesham Shaaban, CFA

@HedgeyeInternet 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.33%
  • SHORT SIGNALS 78.51%
next