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Takeaway: UA is neck and neck with NKE on Branding. But is still playing JV in parts of ops/fin - as shown by this TSA event. That matters at 65x pe.

We think that this UA miss matters more than the market probably thinks it does. We don’t fault UA one bit for taking a financial hit from the TSA bankruptcy. It’s part of doing business. If this were a company like HBI, it would take a special charge. But it’s not. UA is taking its lumps. Golf Clap for that one (and we mean it).  But we definitely question the timing and magnitude. If nothing else, this has to raise an eybrow as it relates to the financial controls inside the company. We know that any mention of ‘financial controls’ sounds alarming. If this were just any company, we wouldn’t raise a stink. But UA just replaced its CFO, and its stock trades at nearly 65x earnings. Yeah, we know the company took up its sales guidance, and that the Brand is ‘white hot’. Some would argue that’s all that matters, and they might very well be right.

But for this kind of multiple, we think it’s fair for shareholders to demand a Great Brand, AND a Great Company – the two don’t necessarily go hand in hand. For all its consistency over the years, particularly during this economic expansion, its financial controls have never been meaningfully stress-tested. Well, here’s a stress test. And if it’s pass/fail, we think it’s safe to say that UA failed. Again, at 65x earnings, we HAVE TO demand excellence across the board. If anyone thinks otherwise, we simply think they’re not being intellectually honest.

Let’s Look At The Timeline Of Events:

  • 3/2/16: TSA filed for bankruptcy planning to close 140 stores.
  • 3/4/16: UA proceeded to update its guidance, saying that the TSA announcement ‘had no impact on its guidance’.
  • 4/21/16: UA then raised its guidance when it printed positive 1Q results.
  • 5/18/16: TSA announced it would be closing all 450 stores.
  • 5/31/16: (2 weeks later) UA updated guidance to reflect the loss of TSA as a distribution partner.

There’s A Few Things That We Find Interesting

1) There was ‘No impact’ when TSA planned to close 140 stores, or 1/3 of its fleet, but a 13% earnings hit to UA when it closed the other two-thirds. That makes little sense to us.

2) The Impairment Seems Reasonable. At the end of FY15, the balance of TSA receivables was $32.5mm.  UA was therefore able to recoup almost $10mm as TSA entered bankruptcy and now takes a $23mm impairment, putting TSA at 4% of DSO, in line with its percentage of UA sales.

3) But SHOULD it be in line with others as a percent of sales? We’d argue that any company worth its salt would have seen this bankruptcy coming from a mile away – at least a year or two out. Nike has about 2.5x the exposure at TSA than UA, and we’d bet that its claim in the bankruptcy courts will be around the size of UA’s. The difference is that Nike has likely been tightening its TSA receivables meaningfully over time to mitigate exposure to this kind of event. It does not appear that UA has been following suit.

Our point here is that UA has been closing the gap meaningfully with Nike over the past few years in the US, which is next to impossible to do. Most of us simply think that the same is happening operationally and financially. But that has yet to really happen. The good news for UA is that this can certainly be fixed, and we think it’s a priority. But when investors evaluate UA’s multiple today, this ‘room for improvement’ behind the scenes should be considered.  When the economic cycle ends it matters most.