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Under Armour (UA) Has Fallen 46% in Last One Year, Underperforms Market

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  • UA
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If you are looking for the best ideas for your portfolio you may want to consider some of Saga Partners top stock picks. Saga Partners, an investment management firm, is bullish on Under Armour Inc. (NYSE:UA) stock. In its Q2 2019 investor letter – you can download a copy here – the firm discussed its investment thesis on Under Armour Inc. (NYSE:UA) stock. Under Armour Inc. (NYSE:UA) is a footwear company.

In August 2019, Saga Partners had released its Q2 2019 investor letter. Under Armour Inc. (NYSE:UA) stock has posted a return of -46.4% in the trailing one year period, underperforming the S&P 500 Index which returned 9.2% in the same period. This suggests that the investment firm was wrong in its decision. On a year-to-date basis, Under Armour Inc. (NYSE:UA) stock has fallen by -49.7%.

In Q2 2019 investor letter, Saga Partners said the fund posted a return of 11.3% in the second quarter of 2019, outperforming fund's benchmark the S&P 500 Index which returned 4.30% in the same period. Let’s take a look at comments made by Saga Partners about Under Armour Inc. (NYSE:UA) stock in the Q2 2019 investor letter.

"Sales and operating income grew a respective 4% and 14% in 2018 and are expected to grow a respective 3% and 30% in 2019. Operating income peaked in 2016 at $417 million and is still recovering from the 2017 headwinds and subsequent restructuring plan.

Under Armour’s key advantage is its brand. It can be difficult to distinguish between an enduring brand or a trendy fad. Brands are a promise built over many years and interactions between a company’s product/service and its customers. With brands, there is customer captivity within the search costs of not knowing if a non-branded product will be of similar quality to something you are familiar with. What is the value to a consumer in drinking Coca Cola or using Crest toothpaste versus a private label alternative?

A brand in and of itself is not necessarily a competitive advantage. For example, Mercedes Benz is one of the most admired and respected auto brands in the world. Its brand has been a status symbol for quality and success; however, the brand has not translated into significant profitability for the company throughout the years. It is the barriers to entry that determines whether an advantage truly exists and therefore provides a company with above average economic returns.

U.S. luxury auto manufacturers did not always earn lackluster returns. Before foreign luxury cars entered the U.S. in the 1970s and 1980s, Cadillac and Lincoln had attractive returns on invested capital. These high returns attracted Mercedes and BMW to enter the market, later followed by Lexus, Acura, and others. While the prices on these luxury cars remained at a premium price point, total U.S. auto demand remained stable while the market became more fragmented among the many luxury auto manufacturers. Unit sales declined for Cadillac and Lincoln and were then shared among several other competitors. The companies still had to spend heavily on product development, advertising, and its service networks but the fixed costs were spread across fewer sold cars, therefore increasing fixed cost and lowering net profits per car sold.

Alternatively, the larger sports apparel companies such as Nike, Adidas, Anta (Fila), Columbia Sportswear, and Under Armour until recently, have all consistently earned very attractive returns on capital. Each of these companies sells its products around the world and to a similar target market.

If the returns are so attractive, why don’t new competitors enter the market, undercut on price, steal share, and inevitably push returns down to just average? The answer is barriers to entry, a large and growing end-market, and the primary competitors each trying to sell high quality, premium priced products.

It takes many years and interactions with athletes to build trust that a product is high quality and will perform as expected. Under Armour and Fila are the only major sports apparel companies to emerge as players on a global scale in recent decades. Under Armour was started in 1996 and had 2018 sales of $5.2 billion. Fila is headquartered in South Korea, started in 1991 and had 2018 sales of $3.6 billion. Lululemon is in a similar category but is more focused on serving the highend female athleisure market. It was started in 1998 and had 2018 sales of $2.6 billion. Outside of these companies, few have been able to go head-to-head with Nike and Adidas. It has proven very difficult to start and build a widely accepted/trusted sports brand.

While economies of scale will make it difficult for many new sporting apparel companies to pop up, it is true Nike and Adidas, being a respective 7x and 5x Under Armour’s sales, have a relative advantage. Nike and Adidas’ size gives them wider brand recognition, relationships and negotiating power with suppliers and distribution channels, and marketing and sponsorship deals with top athletes. Despite Nike and Adidas’ favorable unit economics, Under Armour was able to prosper and become the fastest athletic apparel brand to reach $500 million and then $1 billion in sales, initially growing in its niche Football market and expanding from there.

Beyond the barriers for new entrants, the major existing players have another advantage, they are all focused on providing premium, high quality products. This helps all three earn attractive economics. Let’s say there was a Nike, an Adidas, and an Under Armour jacket on sale for $100 each. A competitive market would expect one company to discount itsjacket to $80 to take market share, sell more jackets, and make more profits. Subsequently the other companies would lower their prices as well until the price reaches a point that profits become unattractive.

While this is what is to be expected in a competitive environment, if each of the three companies were determined to sell high quality products at premium price points and the market demand was large enough to support all three companies, each could earn attractive returns.

The above example and investment thesis for the premium sports apparel industry assumes all three major companies want to sell premium products and won’t discount products to the point it makes them economically unattractive. This thesis was tested in 2016 when Sports Authority filed bankruptcy which impacted the entire U.S. sporting goods industry, particularly Under Armour which had 90% of sales in the U.S. at the time. Retailers were stuck with excess inventory and forced to discount and move apparel to off-price channels. Nike poured fuel on the fire when it reduced its minimum advertised price in late 2016 for the first time in its history, allowing retailers to advertise discounts by as much as 25% on its shoes and apparel during 2017.

Companies that go through some type of adversity and survive, often come out stronger on the other end. Since 2016, excess industry inventories have declined, Nike’s minimum advertised price returned to normal, and Under Armour has refocused on operational efficiencies through better segmented product, inventory management, and SKU rationalization.

While we expect each of the major sports apparel companies to fare well financially over the long-term, we think Under Armour shares look attractively priced to outperform going forward. Under Armour has the ability to compete with the big players and grow from a much smaller base as they continue to achieve greater economies of scale. Once its cost structure is optimized and margins return to historic levels, we expect earnings power to reaccelerate."

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milan, detail, fashion, week, clothing, glitter, people, gems, elegant, trend, woman, trendy, colorful, style, accessory, street, event, shoes, sneakers, blue, miu

andersphoto / Shutterstock.com

In Q2 2020, the number of bullish hedge fund positions on Under Armour Inc. (NYSE:UA) stock increased by about 8% from the previous quarter (see the chart here), so a number of other hedge fund managers seem to agree with UA's growth potential. Our calculations showed that Under Armour Inc. (NYSE:UA) isn't ranked among the 30 most popular stocks among hedge funds.

The top 10 stocks among hedge funds returned 185% since the end of 2014 and outperformed the S&P 500 Index ETFs by more than 109 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds' poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Below you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.

Video: Top 5 Stocks Among Hedge Funds

At Insider Monkey we leave no stone unturned when looking for the next great investment idea. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. We go through lists like the 10 most profitable companies in the world to pick the best large-cap stocks to buy. Even though we recommend positions in only a tiny fraction of the companies we analyze, we check out as many stocks as we can. You can subscribe to our free enewsletter below to receive our stories in your inbox:

Disclosure: None. This article is originally published at Insider Monkey.