With Strong Growth Potential Under Armour Stock Is A Buy

• Under Armour missed consensus earnings estimates for the first time in 25 quarters.
• Under Armour has strong growth potential especially in China.
• Under Armour stock is still a stock to buy.

Whether it is Michael Phelps winning his 23^rd gold medal at the Rio Olympics, and in the process becoming the most decorated Olympian ever, or Andy Murray winning the Wimbledon and then going on to win the Olympics gold or Stephen Curry winning the second MVP in NBA, Under Armour has hit the jackpot with brand ambassadors. And this strong list of brand ambassadors has helped Under Armour to post strong sales growth quarter after quarter.

The last earnings marked its 25^th consecutive quarter of 20%+ YoY growth. The company has grown from a revenue of $430 million in 2006 to almost $4 billion in 2015, nearly 10X growth. And this performance has reflected in Under Armour’s stock price. There have been only few companies which have been consistently creating value for shareholders in last 10 years the way Under Armour has. Under Armour has generated around 850% return in last 10 years.

Source: Under Armour Stock Price Chart by amigobulls.com

The Earnings Miss

But the latest quarterly results have put a break on Under Armour’s stock. The latest earnings release was the first in 25 quarters where Under Armour didn’t deliver on expectations, missing the earnings estimate by $0.01. The quarter also saw the company reduce its sales guidance from 26% growth to 24% growth. Ideally, an earnings miss coupled with a reduction in sales guidance should have taken a heavy toll on any stock, especially a stock like Under Armour which is trading at 54 times its forward earnings and more than 100  times its trailing twelve months earnings. But the stock got away lightly. And rightly so. The miss on earnings was largely due to a one-time hit relating to liquidation of Sports Authority.

The bankruptcy of Sports Authority, the largest seller of Under Armour’s product, took a heavy toll on Under Armour’s profitability. Earnings declined 58% YoY with operating margin for the quarter coming in at 1.9% compared 4.5% a year ago.

Kohl’s deal And China will shore up revenues

To reduce the impact of Sports Authority’s liquidation Under Armour has signed a deal with retail chain Kohl’s (NYSE:KSS). Kohl’s has more than 3X the number of stores compared to Sports Authority. This deal will definitely help UA continue its strong growth. According to Morgan Stanley Analyst Jay Sole, the Kohl deal brings in a $190 million sales opportunity for Under Armour. While the Kohl deal will provide Under Armour with large selling points, it is also likely to impact its margins.

But the largest growth frontier for Under Armour is the international market, especially China. Under Armour’s international sales grew by 68% while China Year to date revenue was up by 164%. And management is heavily upbeat about China. In a recent interview, the company’s management described China as an enormous opportunity.

While the Chinese economy has indeed slowed down, it has not collapsed, as many had feared. The country still continues to grow at above 6.5%. Retail sales in China are expected to grow above 10% till 2020, providing Under Armour with a strong long-term growth opportunity. Unlike its competitors Nike and Adidas, UA is not planning to open a large number of retail stores. Instead, it’s planning to partner with e-com companies to drive its growth. And Steph Curry will be making his second visit to China later this year to promote Under Armour.

Under Armour has inventory problems

While growth has been good for under Armour, the lack of profitability has been a problem. And one of the main reasons for low profitability is high inventory.  Under Armour carries huge inventory which has multiple problems attached to it. Larger inventory means more spending on space and maintaining inventory. The huge inventory also increases the cost of obsolescence. Under Armour has been forced several times to provide heavy discounts to clear its inventory, which further compresses its margins. In the latest quarter Under Armour’s inventory grew by 30%, far higher than the growth in its sales. But the management is taking concrete steps to check the inventory pile up, with the target of matching inventory growth to sales growth.

Conclusion

Under Armour stock has recovered from the post earnings low and is inching forward. But the stock is still more than 10% down from its 52 week high. The company will continue to grow its revenue by more than 20% for the next few years. Profitability is also likely to improve as the one time effect of liquidation of Sports Authority fades and management gets a better grip of the inventory. The recent decline in the stock price is a good chance to buy into Under Armour stock.