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At Its Current Stock Price, Under Armour Inc. Is Overvalued

Ronald Thomas, CFA

The current stock valuation for Under Armour Inc (UA) suggests that investors feel the company is on its way to becoming the next Nike, Inc (NKE), and that no one is expecting any hiccups along the way.

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The stock, at its $59 price, discounts a 27% five-year growth rate in EPS, based on its $1.64 consensus four quarters ahead EPS. The sell-side average growth rate is only 22%, resulting in a 5 percentage point spread over what has been an extremely good indicator of overvaluation (i.e. the sell-side five-year growth rate is almost always too high) in my investment career. If 22% growth is the right value, the stock should be $46. (I am using a 4.5% risk-free rate, and 7% equity risk discount for Under Armour -- and for perspective, I use 6% for Nike.)

My concerns for the growth rate are basically qualitative now, as so much of the growth story seems to be based on a continuation of strong sales and present sales momentum, as the company seemingly moves down the path sort of parallel to Nike, though starting with apparel and going then to shoes.

To approximate sell-side consensus, I have been looking at a sell-side five-year income statement projection model that shows a 23% compound EPS growth rate, with total revenue growing at a 17% rate from 2012. Apparel and footwear both grow at 18% and accessories grows at 15%. Gross profit grows at 18%.

Footwear would be my biggest problem. The athletic footwear markets are more mature now than when Nike did its thing; there are larger companies to contend with that know how market to younger and impressionable consumers and pay for the important endorsements. Even the smaller companies have had time to establish strong niches, such as Saucony and Brooks in running. Footwear margins are about 15% below the company's average. UA's strength in cleated shoes presents a good quality image to start in the running and basketball arenas. But there has been no real establishment of sales strength in the $100+ segment with the company's Spine technology yet, so I would not want to give them the growth credit that this analyst's model does. It also seems quite possible that another heavy duty competitor in the shoe segment -- even one committed to a very premium image -- is likely to, in the end, lower the margin structure for the entire industry.

In apparel, the cotton moisture wicking has been copied down to the Wal-Mart (WMT) level, and the water repellency and heat reflection of Storm Cotton and Coldblack should be expected to be copied in a year or two without any patent protection. As more apparel is sold into the department store channel, rather than sporting goods stores, I would expect that gross margins would have to be under some pressure, given the less affluent, less sports/fitness-focused customers served. Also, margins will likely come under pressure in the sporting goods stores, if more apparel innovations are not forthcoming in the next few years. The top of UA's price range is now higher than the top of Nike's range in Dick's Sporting Goods Inc (DKS).

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The international business growth is starting from a low base and the real sales acceleration is not likely until fiscal 2016. There is enough economic uncertainty now to question if the same proportion of high-end apparel will be sold, as is now the case. Additionally, the big push in women's apparel is yet to come and I would like to see some traction there to solidify a growth rate expectation.

Yet by this analyst's model, the gross margin, ex-licensing revenue, increases from 46.6% in 2012 to 48.1% in 2017. I think this is optimistic.

Getting back to the international business, the overhead expenses for it will be incurred sooner than the F'16 sales growth.

The downward adjustment in US GDP for the first quarter adds the risk that near-term comparisons could be less than the most optimistic holders are expecting.

My bottom line is that I cannot point to a decent catalyst to drive the stock down in the short term, but I cannot make any case for a 27% -- or even a 22% -- five-year growth rate, either.

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