EUR 850.00 For Business Accounts Only

Morningstar | Under Armour’s Moat Rating Lowered to None on Competitive Weakness; Fair Value Estimate Reduced

We no longer believe Under Armour has a narrow moat based on its intangible brand asset and are lowering our moat rating to none. We have also reduced our fair value estimate on Under Armour to $16.60 from $20.50 as we no longer believe the firm can generate excess returns for more than 10 years. Although Under Armour is the third-largest athletic apparel firm in the U.S., we think it has fallen behind in innovation and its product is not sufficiently differentiated. We believe Under Armour’s relationships with retail partners like no-moat Dick’s Sporting Goods have suffered as a result.

We think Under Armour has lost its competitive edge. The firm suffered two poor years in 2017 and 2018 as it worked through excess inventory and operational problems. We do not think Under Armour will return to growth rates above 15% in North America that it consistently achieved prior to the 2016 bankruptcy of Sports Authority. We forecast its North America growth will gradually rise to 5% in 2022 and stabilize at that level. As this growth rate is roughly equivalent to our forecast of activewear market growth in North America, we do not expect Under Armour’s market share to improve in the long term.

Under Armour’s margins have declined as its competitive position has weakened. The firm’s gross margins have been impacted by excess inventory and discounting, falling to an average of 46% in 2016-18. We forecast Under Armour’s gross margins will average 48% over the next decade, matching the 10-year historical average but below the peak level of 50% achieved in 2010. Further, we expect Under Armour will incur additional cost as it builds its e-commerce and international businesses. We have increased our expected average annual selling, general, and administrative expenses over the next decade by 2 percentage points as compared with our previous view. This has reduced our average annual operating margin expectation over the next decade to 7.5% from our previous view of 10.0%.

We have lowered our stewardship rating on Under Armour to Poor from Standard. The firm has produced a three-year average annual shareholder return of negative 23%, far short of the three-year average annual return of 4% for apparel manufacturers. We consider Plank’s majority voting control of Under Armour as unfavorable to shareholders as he can elect the entire board. We also have concerns about management turnover at the company.

We think Under Armour’s compensation policies need improvement. The firm does not use optimal incentives like free cash flow and ROICs. Instead, it uses adjusted operating income as its performance measure for its equity and cash incentives for executives. Further, Under Armour’s target level of adjusted operating income was drastically reduced as the company experienced two difficult years in 2017 and 2018.

We believe Under Armour’s acquisitions have reduced shareholder value. The firm supported its fledgling connected fitness segment by spending $710 million to acquire fitness apps in 2013 and 2015. Under Armour, though, abandoned its fitness hardware business in 2017. In 2018, its connected fitness segment produced just $120 million in revenue and an immaterial operating profit of $4 million. We believe Under Armour overpaid for its fitness apps and may have better served shareholders through other investments.