This Under Armour print was as vanilla as any we can remember for this company. The growth algorithm was far from perfect, particularly for a company trading at 60x earnings. But at least from a trading vantage point, short interest doubled from 15% in April to 30% today – which probably made the event a push from where we sit given an in-line print and guide.
But we hardly cared about the quarterly numbers when management gave us the gift of its new bifurcated distribution strategy – basically it is attacking the high end and the low end of the consumer spectrum simultaneously.
The biggest factor of this strategy – by a mile – is the fact that UA will sell into Kohl’s starting next year. Yes…UA + KSS. While some brands have navigated this in the past without blowing up – Nike and Ralph Lauren, most notably – we’d note that announcing Kohl’s as a distribution partner is usually Brand-suicide. And relative to expectations, it’s proven to blow up more than a few investors who are betting on a benefit to KSS. How we’re doing the math, it’s about $70mm (1.5% growth) to UA, which might be a nascent tailwind – presuming the company can tier the product appropriately to mitigate cannibalization. And despite what people are already speculating, this is only a 0.5% comp boost to KSS – at best, and a likely set-up for a disappointment for America’s favorite remedial-quality retailer.
Lets Look At Some Raw Numbers:
The high-end strategy is best represented by the push in to UAS (Under Armour Sportswear), which will distributed at ‘Best’ department stores and fully controlled DTC, and the continued investment in Brand Houses in top retail markets. Both will require a material capital investment with the store portion making up the lion’s share of that. Look no further than the newly announced UA store in the old FAO Schwartz digs. It will be the company’s biggest store by at least 20k sq. ft., but it’s also in the 0.1% in rent terms in the world. Can UA pull it off? Probably, but a lot can change in 3yrs by the time the company gets that monster opened.
On the low end, this is where we think the conversation gets interesting. Not only for UA, but for one of our top short ideas in the retail space, KSS. The new bit of information being that KSS would carry UA footwear and apparel product in about 600 of its locations starting in FY17. The two obvious questions that need to be answered are a) what’s the risk to UA by going lower down the value chain in the US (from our perspective KSS is the lowest of the low), and b) what does the new partnership translate to in $ for both of the parties involved. More on each below…
Why KSS Now
The sports apparel market in the US sums up to a total of $70bn. With the two biggest players in the space, NKE and UA, sitting at 11% and 5% share, respectively. Nike has the obvious edge in distribution (with 24k points in distribution vs. UA at 11k in the US) having entered into the likes of KSS and JCP 20+ years ago. But it’s also tiered the distribution across multiple sub-channels in Brick and Mortar retail better than any other brand on the planet. The risk here for UA is that the brand doesn’t get the tiered distribution right, bungles its premium cache, and follows the road map laid out by Adidas, Reebok, and Columbia.
Columbia being the most relevant example we can point to in order to gauge the downside risk. The brand started getting distributed in earnest in the early 2000’s. Following that strategic decision, Columbia gross margins collapsed by 500bps and the multiple was cut in half. It took the brand almost a decade to see a positive inflection in either metric.
That’s the worst case. But we’re willing to give the company the benefit of the doubt on its decision to tap KSS. The fact is UA is at a phase in its growth cycle where it needs to widen the aperture to continue to take share, even if that means doing so with Kohl’s. And, this has been a management team that has a track record of making the right strategic decisions. In its 11 years as a public company nearly everything with the exception of maybe Int’l has been executed upon exceptionally well. And that one black eye has earned a gold star over the past 3 years.
What’s The Upside
Let’s first start at the top with the details of the new distribution agreement. This is a FY17 event, and will see UA take floor space with both apparel and footwear in about 600 doors, with the potential for a full fleet roll out at a later date. News outlets are reporting that it will be fleet wide, though Plank on the call seemed less committed. Our take is that anything more than 600 doors would makes us start questioning UA’s thought process on the deal – especially in light of the fact that KSS management has even stated that it has more doors than it needs by as much as 1/3rd.
Today we know that Nike has an $800+mm business within all of KSS’ doors. When we do the math on that (full explanation below) we get to $70mm revenue opportunity for UA in year one, which is good for 1.5 points of growth. Assuming a 25% growth rate going forward it’s an additional 30bps in growth in year two and beyond. Additional upside could be recognized if the partnership is rolled out across KSS’ fleet of 1100 doors.
For KSS, the math is a little trickier, because the UA will be displacing existing product in the store – something people tend to forget when discussing new brand offerings. By our math the UA opportunity in year one is $142mm, that will be displacing about $53mm in product which we assume has a productivity rate at 75% below the company average, for a net total of $89mm or about a half of a point in comp. Maybe good for a retailer who struggles on its best day to hit positive territory, but not enough for a concept that has one of the leanest cost structures in retail and needs a 2% comp to leverage fixed expenses.
Lastly…Ignore the KSS Hype
Specifically on KSS, this UA announcement is a non-event. Yes, it’s a considerably better brand than most of the current portfolio, but brands pop in and out of the assortment every year. The news was announced just a few hours ago, meaning the hype machine hasn’t kicked into full gear and probably won’t until KSS reports numbers in mid-August. So we thought we’d run a refresh on the last time the street got over excited on KSS’ addition of new brands. That was back in 2015 with the addition of Juicy and Izod. To provide context we looked at expectations before the year started for each quarter to gauge the expected ramp in comp store sales , and what the ultimate reported metric was. The result…a 100-200bps spread in the expectation vs. the reported number. The punchline = don’t believe the hype.
Key Assumptions/Conclusions In UA/KSS Math
1) Nike revenue at KSS $825. That’s 4% of KSS’ current revenue base.
2) Productivity on the floor space NKE product lives inside = 3x the company average. In excess of $550/sq.ft. (including e-comm sales) vs. the $191 company average.
3) Nike has a 1,500 sq. ft. footprint inside each KSS door.
4) For UA we assume the company only enters 600 doors, and has half the floor space allocated to Nike.
5) On that floor space we assume a 2x premium to the company average, heck it took NKE 20yrs to get to 3x.
6) That gets us to $142mm in revenue for UA inside KSS (half that rate shows up on UA’s P&L).
7) That displaces $53mm in what we call legacy product which we assume sells through at 75% the rate of the company average.
8) That nets out to an $89mm benefit in year one to KSS from the addition of UA or a 0.5% lift to comps. In year 2, assuming a 25% growth rate (about in-line with NKE comps at KSS over past 2yrs), it’s an additional 2 points to comp.
9) There is also margin considerations to consider, with National Brands coming in at a lower margin from the likely Private Label product it will be displacing. We’ll revisit that at a later time.