Under Armour: Through the Worst of the Storm?
Last week, Under Armour (NYSE:UA)(NYSE:UAA) reported results for the second quarter of fiscal 2020. Revenue declined by 41% in the quarter to $708 million, led by a nearly 60% reduction in Wholesale revenues as roughly 80% of the locations where Under Armour products can be purchased around the world were closed throughout much of the quarter (direct-to-consumer sales declined 13%, with strength in e-commerce offset by the closure of company-owned doors). While the results were clearly unimpressive, with a further deceleration from the 23% decline in revenues in the first quarter, it was better than the 50% to 60% revenue drop that management anticipated.
The weak results were across all markets and product categories, with North America revenue down 45%, Asia-Pacific down 20%, Europe, the Middle East and Africa down 39% and Latin America down 72% (collectively, international revenues declined 37% for the quarter on a constant currency basis).
The sizable decline in revenue left Under Armour with too much product: at the end of June, inventories were up 24% year over year to $1.2 billion. This is a problem for a number of reasons. First, inventories consume a fair amount of capital during a period where liquidity remains a concern (inventories account for more than 25% of the company's tangible assets). Second, despite a reduction in planned purchases in the back half of the year, the company will still need to work through a fair amount of excess inventory (which will require discounting and negatively impact gross margins). Third, there are other companies in a similar position, which will impact competitive behavior (management is expecting a "highly promotional environment" in the back half of 2020). Finally, outsized inventories have constrained the company's ability to commit to product buys for the second half of the year (Under Armour "significantly reduced planned inventory purchases" in recent months). That last risk cuts both ways: if a recovery occurs faster than anticipated, the company will not have adequate supply to meet consumer demand.
Given the severity of the revenue decline experienced in the first half of the year (down 32% to $1.6 billion), management has moved quickly to adjust the cost structure and conserve liquidity. In the quarter, selling, general and administrative expenses declined 15% year over year, largely due to a meaningful cut to marketing spend. The combination of the 41% revenue decline and an inability to adjust the cost structure in the short term led to an adjusted operating loss of $131 million.
At quarter-end, the company had $1.1 billion in cash and equivalents, compared to $1.2 billion in debt. That figure is inclusive of $500 million in convertible notes that the company issued in May, with the majority of proceeds used to reduce outstanding borrowings under its revolving credit facility. Under Armour has taken these steps in an attempt to shore up its financial position - a primary focus for the company given the recent struggles in the business. For now, the company is more focused on survival than playing offense (rightly so). Looking out longer term, that can be an issue for a company that feels the needs to rebuild its brand, as CEO Patrik Frisk alluded to on the call.
Conclusion
As noted earlier, roughly 80% of the brick-and-mortar locations around the world where Under Armour products are sold were closed for much of the quarter. Today, while most company-owned and wholesale partner doors have reopened, the company is still seeing "considerably lower" traffic than a year ago - and management does not expect that to change before the year ends.
As noted on the call, there's still a high degree of uncertainty in terms of the duration and the extent to which the pandemic will have a long-term impact on global retailing (if any). For athletic apparel brands like Under Armour, I think it's likely that we see an acceleration in the trends that have been underway for some time - most notably mix shift towards DTC and the importance of best-in-class consumer facing digital offerings. Unfortunately for Under Armour, I believe the company remains a clear laggard in these areas relative to industry leader Nike (NYSE:NKE).
In the short term, UA has a number of issues to address. It needs to right-size its expenses for lower revenues (expected to decline by roughly 25% for the full year to $4 billion, which would be comparable to 2015 revenues), sell through excess inventories without further impairing the brand, and ensure the financial stability of the company in the face of large operating losses.
Personally, while I can understand why an investor might take a flyer on the equity at its current valuation, I need to see more signs of progress before I'd be willing to make a similar bet. I also continue to worry that changes in the industry - most notably mix shift to DTC and digital - further disadvantages UA relative to peers like Nike and Adidas. For now, I'll stay on the sidelines.
Disclosure: None.
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This article first appeared on GuruFocus.
