Under Armour class A share price has come down significantly in the past few months despite outpacing peers and indices since inception as a publicly-traded firm (as illustrated by Fig. 1 in appendix), which could be attributable to a sales growth decline in 2016, a slight decline in operating margin (of 1.6 percentage points from 2015 to 8.7% in 2016), uncertainty about the future of its distribution channels (sporting goods and mall-based stores), and skepticism over its ability to capture additional markets (footwear, connected fitness, women, international). However, I believe that Under Armour’s business prospects and current share price, make it an attractive long investment.
• Wide market opportunity: The market is undervaluing the addressable market that Under Armour has remaining and its growth potential as it becomes a truly global fitness lifestyle brand. At inception, Under Armour addressed an unfulfilled need by the athletic performance market (for sweat-wicking, and heat-retaining fabric) and has since gained an almost “cult-like” brand loyalty particularly among the teenage athletic demographic. Under Armour recognizes its over-indexing on US-based male athletes and has since diversified to women athletes, casual wearers (fashion rather than athletic wear) and internationally. Additional growth areas include direct-to-consumer and connected fitness.
International sales still account for a very small proportion of total revenues (just 17% of sales in 2016) and there remains tremendous opportunity in women’s apparel, particularly with a shift into athleisure. To the extent that Under Armour could penetrate the women’s activewear market dominated by the likes of Lululemon and Gap Inc.’s Athleta, it would be well positioned to expand revenues rapidly due to both higher price points (comparable to LULU and Athleta) and greater addressable population. Many doubters believe that athleisure is simply a fad; however, UA’s competitor Nike showed that with a strong enough brand and proposition to customers, an entire lifestyle change can be built. Before Nike, “sneaker” lifestyle was certainly not nearly as prominent in the US and Europe.
• Brand power/partnerships: The market is also undervaluing Under Armour’s brand is built on its reputation for high-quality performance materials that can weather wear and wash. Indeed, in the Q4’16 earnings call, CEO Kevin Plank remarked that while they are strategically moving into apparel at large, “performance” quality is still something that is very much expected of them. Through this enduring commitment to quality products, Under Armour has been able to garner value-additive partnerships, including one with Samsung to develop connected fitness applications. Connected Fitness is a binary bet for Under Armour. Though currently small, if it does take to market, it could follow on the success of devices such as the Apple Watch and FitBit. It could be revolutionary: UA’s existing R&D in materials technology could enable it to incorporate fitness tracking into clothing and accessories in ever novel ways. On the flip side, even if it does not take off, UA’s business prospects are virtually unharmed since it is such a small part of their business (1.7% of revenues for FY 2016).
• Channel/omnichannel: The opportunities for Under Armour to expand via channel opportunities is tremendous. In the FY15 shareholder letter, management pointed out the desire to provide products at multiple price levels and offer superior alternatives to competitors. UA has delivered on this by distributing through wholesale, opening its own retail stores, and more recently, offering outlet alternatives. This allows UA to effectively price discriminate. In addition to marketing through several fitness arenas, UA is also unique among its peer group in its aggressive pursuit of the direct-to-consumer channel through online. Unlike Nike and Adidas, UA has fewer physical stores, so it does not bear as tremendous a restructuring cost as the two larger players would in converting to e-sales. Interestingly, UA also has far more factory stores (151 as of 12/31/16) than house retail stores (only 18 as of 12/31/16). I believe that they are astutely using house retail stores only as a “seat saver” (a la Warby Parker model) in major athletic cities like Boston, but using factory stores to rid excess inventory without affecting pricing through its other channels (profit-maximizing price discrimination).
• Execution: Under Armour has been successful in expanding its product offering and customer base. For example, in 2016, its newly-minted footwear segment grew 49.1% to $1.0B in net sales, led by running and basketball. The basketball sales give credibility to UA’s sponsorship of the NBA and illustrates that such marketing efforts are bearing fruit. But what is more impressive is its penetration into the running population, an area once well-guarded by the two major US shoe-dogs, Nike and Adidas. This gives me high conviction that Under Armour would be able to expand its brand reach to geographies where brand perceptions matter (e.g., East Asia, Europe) and technology via connected fitness.
Valuation: Based on a 15-year DCF, Under Armour has a fair price of about $28/s, which represents 40%+ upside. This intrinsic valuation acknowledges a continuation of its current high growth in apparel, footwear and accessories for the next 5 years, then tapering off to a 3.0% growth rate which it will continue beyond the explicitly modeled period. This 3.0% reflects long term GDP growth of the global markets and productivity gains.
