Here’s an important callout from UA’s 10K that will likely impact earnings, margin flow through 2018. It’s bullish on the margin. Specifically, UA has increased the reserve allowances for returns, markdowns and discounts by $100mm.. to $246.6mm in ’17. That’s a direct hit to revenue in 2017, while incurring the cost. So reversing the allowance will benefit revenue in the future and be pure margin. It’s pure margin, because the cost was previously incurred.
As a percentage of sales it grew 200bps, to 5%, in 2017...
Markdown/returns allowance as a % of sales: 2015: 2.4% 2016: 3.0% 2017: 5.0%
Inventory growth of 26% vs. 4% sales growth in Q4 is the biggest pressure on the P&L and a large concern for investors. Even if the reserve amount was appropriate UA is unlikely to maintain the reserve allowance at 5% of sales in 2018, so it will be a top line and margin tailwind in the future. The allowance for doubtful accounts was increased by $8.4M in 2017 as well. (BONT?) So already taken the hit. Magnitude - Returning to 2016 reserve levels would double the EPS expected for 2018. Granted, that’s only $0.17, but people playing the margin story should latch onto this if they haven’t already.
Hypothetical example that may help:
Let’s say DKS was the customer and UA said it was reserving for $100mm of the $200mm sales to DKS in 2017 to be marked down.
So revenue is reversed in 2017 and the allowance is increased. The COGS did not change so a big hit to bottom line (by the merchandise cost).
Now in 2018 let’s say UA decided it was overly conservative by $50mm – well $50mm gets added to revenue without any associated cost, drops to EBIT and the allowance goes down by $50mm.
Also UA sales to DKS in 2018 don’t have to be reserved by as much.
So instead of UA reserving half of it, UA only reserves 3% so on a YY basis revenue and profit will look that much better in 2018.
Conjecture on my part, but I think the new CFO knew the company couldn’t keep missing under his financial leadership so he aggressively increased the allowance.
- Dave Bergman was named acting CFO on Feb. 3, 2017 and was on the Q4 call on Jan. 31. So the initial guide for 2017 was Molloy’s but Bergman communicated it on the call.
- Q2 call revenue guidance was lowered by 2-3%. EPS guide was $.18-.21, but excluding restructuring plan $.37-.40.
- Q3 call revenue guidance was lowered by another 6-7%. EPS guide excluding restructuring plan was now $.18-.20 (so cut in half).
- Bergman named full time CFO.
- Q4 finally met guidance provided in Q3.
- Adding to the allowance must have been happening in Q3 and Q4, but I think new CFO knew the company couldn’t keep missing and decided upon the allowance increase in Q3 call.
As Brian outlined in our UA Blackbook on 3/20 (LINK: CLICK HERE), we think this is an $8 stock – the question is when. If Kevin does what he SHOULD do to build the right organization structure, then we should see a loss of -$0.30-$0.40 for 2-3 years. That could set up the best long in Retail. Flip side is that he could run for making this a cost cutting and ‘normalized margin’ story with eroding top line growth. That’s very defensive and shortable. As these manufactured margin boosts boost margin with sales remaining punk, we’ll get much much heavier short side.
-- Daniel Biolsi
Director, Hedgeye Retail Team
