UAA | Forgot How To Grow

07/30/19 09:57AM EDT

This is stating the obvious with a high-teens sell-off in the stock, but there was absolutely nothing redeeming about this UAA quarter to the extent you buy into its current hyper-growth multiple. This is a company that is transitioning back into a full price model, hence 120bps higher GM , which is commendable. But the problem is that it can’t drive traffic at full price. Guided 3Q revenue -msd in North America, well below the 2% consensus forecast, with a rebound in 4Q as off price sales pick up again. The only way to fix that is to invest in the brand, but conversely we’re seeing UAA eviscerate its corporate expenses (in fairness it needed some streamlining), but it’s cutting into bone and also pulled back on marketing to hit the quarter. Can’t do that if you want to stop losing share – which UAA is clearly doing right now. This is a business where bigger and better capitalized competitors with far more brand heat are spending money on product and branding like drunken sailors – which is why they’re outgrowing UAA by a factor of 3-5x.

If I put on my bull hat, I could argue that the 17% decline in the stock is severe relative to the operational changes, negative sales developments and reduced 3Q guidance we saw in this quarter. But the reality is that this stock has been on fire – up 54% ytd -- as if revenue growth was accelerating and the company was on track to smoke its guidance for the year. It should simply never have been at $27 in the first place.

As I said heading into the quarter, MUCH longer term, presuming this management team can drive this model higher I can get to $1.10 EPS in 2023. Let’s give that a current day Nike multiple of 31x earnings (one that it’s earned through consistency) – that’s a $34 stock in four years. That’s a $23 stock today at a 10% discount rate – exactly where the stock is trading right now – and that’s if all goes right and it can start taking share from Nike and Adidas, something I won’t bet on for a minute.

OUR NOTE HEADING INTO THE QUARTER

UAA | Could 2Q Be a Short Thesis-Buster?

Takeaway: The rubber hits the road in 2Q – it needs real top line growth at a full price gross margin. Didn’t matter at $20. Matters at $27.

Let’s start with a humbling fact…I have been dead wrong this year being short Under Armour. It’s my worst performer – long or short -- by a country mile. The stock is up 54% year to date, more than double the return of the market. There hasn’t even been a single event that has taken the stock up, it just grinds higher and higher. My view all along is that this stock in the teens and low $20s is all about cost cutting and optimizing the margin structure. But to own this in the mid-high $20s you need to believe it can actually put up respectable top line growth in line with lesser-priced peers. That’s exactly where we are today.  

Now we’re staring down the barrel of a 2Q print where UAA is going up against its toughest compare in two years (it reported +8%-9% top line growth in each of the past two 2Qs). The company has been artful in its guidance – setting up for a beat on most line items in each of the past three quarters – even if the absolute earnings algorithm was sub-par. It guided to ‘up slightly’ top line growth in this 2Q along with 80-100bp gross margin expansion and 4-5% growth in SG&A. I think all of those are doable, and I’m coming in $0.02 ahead of consensus at a $10mm EBIT loss ($0.03 per share – the street is at -$0.05 and guidance is -$0.06).

All eyes are on the top line this quarter. UAA’s gonna beat EPS, and not a single person I talk to thinks otherwise. I’ve heard numbers as high as $0.05 in EPS. But I don’t think that SG&A cuts will do the trick anymore. If the company wants to pull the trigger and sell off-price, it can easily grow 5% this quarter. But I don’t think it’s going to do that. Its strategy is to take the brand back up market, and to managements’ credit, I don’t think UAA will deviate from that plan. I think a $27 stock is expecting top line of 3-4%, which would be 5-6% on a 2-year growth rate – acceptable by any means – especially with FX headwinds. But I’m not seeing anything in the market that suggests that the brand has that kind of heat to get to that kind of growth. If it can put up a 5% top line growth rate with 100bp GM improvement, I’ll bow out and simply admit that my case around the company being structurally unable to grow was wrong. I’ll particularly be looking at the footwear number, where it’s under-growing competitors like Nike and Adidas by a factor of 3. (this long-term model will only work if footwear works).

As for valuation, assuming all goes to plan, this company will earn $0.40 this year, and close to $0.60 next year. Impressive earnings growth, but can we maybe sit back and question whether this is in a stock that’s trading at a 30% premium to Amazon on cash flow? Short interest is down to 20% of the float from 37% at last year’s peak, so the bulls are definitely in UAA’s camp on the margin. One area where I’m different longer-term is that I think we’re going to see a step-up in SG&A spending to a mid-single digit level (roughly in line with sales) and competitors are taking the cost of growth higher. To UAA’s credit, it took its endorsement obligations from $1.2bn to $750mm over just a 2-year period. I think we’ve hit bottom, and if the company wants to grow sustainably from here it will have to be top line and gross profit driven – can’t bank on SG&A leverage anymore with the stock at $27.

Longer term, presuming this management team can drive this model higher I can get to $1.10 EPS in 2023. Let’s give that a current day Nike multiple of 31x earnings (one that it’s earned through consistency) – that’s a $34 stock in four years. That’s a $23 stock today at a 10% discount rate. I know stocks trade far more myopically than that. But the reality is that I think we’re at the breaking point this quarter where the rubber hits the road and the company has to beat on high quality top line. Maybe this will end up being a thesis buster for me, and a feather in the cap for the bulls, but I simply don’t see that coming down the pike. Still Short UAA.

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