EUR 850.00 For Business Accounts Only

Morningstar | Inventory Clean-Up, Footwear Innovations Position Under Armour for Growth, Margin Gains Beyond 2018

Narrow-moat Under Armour continued the previous quarters' trend of muted North American growth offset by strong growth in its international segment (26% of revenue). Inventory management was the key story during the quarter, tying in with our long-term thesis that Under Armour will become more operationally efficient as it moves through its restructuring program. Inventory levels grew at an 11% rate compared with the previous quarter’s growth of 27%. We contend that inventory control is a key aspect of our thesis on Under Armour’s brand intangible assets that underpin its narrow moat rating. As Under Armour continues to use the enterprise resource planning systems, buying decisions improve, and it should not have to rely on off-price channels, which degrade its premium brand reputation. The firm’s results continue to track in line with our full-year expectations, so we're not planning material changes to our $20.50 fair value estimate. As a result, we believe the shares are fairly valued and advise investors to wait for a more attractive entry point.

Under Armour grew its top line 8% (against our 4% full-year estimate), driven by wholesale and international sales. Inventory management and discounting benefited wholesale growth (9%) but also reduced gross margins 60 basis points to 45.3%. Inventory clean-up efforts should continue in the third quarter (the majority of off-price is coming from 2017 inventory), but to a lesser extent with management anticipating third-quarter revenue to be down or flat from last year and the company positioned for a cleaner balance sheet moving into 2019. Our long-term thesis calling for accelerated growth from the international and direct-to-consumer segments remains intact, representing larger percentages of revenue (26% and 35%, respectively). Further, footwear innovations continue to drive full-price growth (15% growth in footwear versus 1% in the first quarter) and additional product sellouts seen with the Rock’s signature shoe.

We are encouraged by the firm’s ability to locate additional efficiency. While these costs weigh on near-term earnings, we believe that in the long run they're necessary for the firm to improve profitability and its competitive position. Highlighted in the earnings call, these costs primarily related to closing underperforming distribution facilities and reducing the number of stock-keeping units. This ties into our long-term forecast, because as the firm continues to improve supply chain we expect operating margins to return to around 10% (similar to Nike, Adidas, and the firm’s former 2013 through 2015 levels of around 10% to 11%) and inventory turns reducing to 130 days (currently at 155).