Global Financial Markets Analysis

UNDER ARMOUR Fundamental Analysis - by Debashis Das & Matthew Semprucci

Quick Facts

52 week range : 29.73 – 62.40 Beta : 0.92

Market Capitalization : 12.73B Institutional Ownership : 83%

Trailing 12-Month P/E : 76.37 Trailing 12-Month EPS : .78

Common Shares Outstanding : 173.96M Dividend/Yield : N/A

Our Recommendation: HOLD

Introduction

Under Armour, Inc. (NYSE: UA) is a developer, marketer and distributor of branded performance apparel, footwear and accessories. The brand’s moisture-wicking fabrications are engineered in many different designs and styles for wear in nearly every climate to provide a performance alternative to traditional products. These products are sold worldwide and worn by athletes at all levels, from youth to professional on playing fields around the globe, as well as by consumers with active lifestyles.

Financial Ratios

Valuation Ratios	12/31/11	12/31/12	12/31/13
Price-to-Earnings	38.91	40.08	58.07
Price-to-Sales	2.56	2.81	4.04
Price-to-Book	5.93	6.32	8.95
Earnings per Share	.46	.61	.75
Enterprise Value	$3.24 B	$4.48 B	$8.55 B
EV/EBIT	20.12	21.44	32.24
EV/EBITDA	16.45	17.77	27.08

Profitability Ratios	12/31/11	12/31/12	12/31/13
Gross Profit Margin	48.40%	47.92%	48.74%
Operating Margin	11.05%	11.37%	11.37%
Net Profit Margin	6.58%	7.02%	6.96%
Return on Assets	12.16%	12.40%	11.87%
Return on Equity	17.10%	17.72%	17.36%

Solvency Ratios	12/31/11	12/31/12	12/31/13
Debt-to-Assets	8.46%	5.35%	3.35%
Debt-to-Equity	12.21%	7.58%	5.02%
Current Ratio	3.76	3.58	2.65
Interest Coverage	42.38	40.27	90.38

	12/31/11	12/31/12	12/31/13
Cash per share	.83	1.61	1.61

Price Performance

Summary

Strong North American apparel business growth of more than 20% for 18 consecutive quarters (as of Q1, 2014).
Strong revenue growth of more than 20% for the 16th consecutive quarter in Q1, 2014, i.e. for the last 4 years.
Expansion into new categories (e.g. golf shirts), new geographies (Brazil & Chile) and new consumers.
Growth fueled by multi-prong approach including foray into digitally connected fitness movement, growth in direct-to-consumer channel.
Current valuation reflects the growth expectations.

Analysis of Recent Results

First Quarter 2014:

Under Armour, Inc. reported very positive first quarter 2014 results on 24-Apr-2014 across all the different metrics in the financial statements. Reported net revenues for first quarter ending Mar 31, 2014 was $641.6 million, year-over-year increase of 36% as compared to first quarter ending Mar 31, 2013 with net revenues of $471.6 million. Operating income (EBIT) increased from $13.5 million in Q1 2013 to $26.9 million in Q1 2014, i.e. almost 100% increase. Net Income increased from $7.8 million in Q1 2013 resulting in earnings per (diluted) share (EPS) of $0.04 to $13.5 million in Q1 2014 resulting in diluted EPS of $0.06, i.e. an increase of 71% in diluted EPS. Gross profit margin grew from 46% for Q1 2013 to 47% for first quarter ending Mar 31, 2014, resulting in 95 basis points improvement. EBIT margin grew from 2.86% in Q1 2013 to 4.19% in Q1 2014, i.e. 133 basis points improvement. Highlights of the quarter included growth across all major reported segments of the business. Accessories net revenues increased 43% from $36 million in Q1 2013 to $52 million in Q1 2014, primarily driven by headwear lines. Footwear net revenues increased 41% from $81 million in Q1 2013 to $114 million in Q1 2014. Apparel which is Under Armour, Inc. biggest business segment grew 33% during the quarter from $346 million in Q1 2013 to $459 million, i.e. an increase of 33%.

Fourth Quarter 2013 and Financial Year 2013:

Under Armour, Inc. reported fourth quarter 2013 and financial year (FY) 2013 results on 30-Jan-2014. Net revenue for Q4 2013 increased 35% to $683 million from $506 million in Q4 2012. For FY 2013 net revenues increased 27% to $2.33 billion from $1.83 billion in FY 2012. Operating income increased from $82 million in Q4 2012 to $99 million in Q4 2013, i.e. an increase of 21%. For the full year FY 2013, Operating income increased 27% to $265 million from $209 million in FY 2012. Net Income increased from $50 million in Q4 2012 to $64 million in Q4 2013 resulting in EPS change of 27% from $0.24 per share in Q4 2012 to $0.30 per share in Q4 2013. For FY 2013 Net Income increased to $162 million from $129 million in FY 2012 resulting in full year EPS increase of 25% from $0.62 per share in FY 2012 to $0.77 per share in FY 2013. Gross Profit Margin also improved in Q4 2013 to 51% from 50% in Q4 2012. Annual improvement in Gross Profit Margin was around 82 basis points to 49% in FY 2012 from 48% in FY 2013. EBIT margin remained roughly the same across FY 2012 to FY 2013 at around 11.37%. Growth across the major business segments in Q4 2013 was again nothing short of great with 35% (to $546 million in Q4 2013 from $405 million in Q4 2012) growth in apparel, 24% (to $55 million in Q4 2013 from $45 million in Q4 2012) in footwear and 52% (to $65 million in Q4 2013 from $43 million in Q4 2012) in accessories.

Business Strategy, Growth Drivers & Investment Thesis/Rationale

Under Armour, Inc. has been performing consistently and has seen growth across all its major segments across multiple quarters. This is reflected in the current stock price which has experienced 5 year return of more than 1000%. Following are some of the avenues which are driving this consistent growth and which we think will continue for some more time before returning to normal growth:

· International Growth – Under Armour, Inc. is in the early innings of its international growth and expansion. Foreign revenues have been growing at a rate of more than 20% on an annual basis. In Q1 2014, foreign revenues experienced more than 90% growth as compared to Q1 2013 and as compared to U.S. domestic revenue growth of 32%. Contribution of foreign revenues to total revenues is also increasing with foreign revenues constituting around 9% of the total revenue in Q1 2014 and up from 6.5% in Q1 2013. We believe that Under Armour, Inc. has a long runway ahead in the foreign markets. Several recent endorsements including signed agreements to outfit leading soccer clubs: Colo-Colo in Chile and Toluca and Cruz Azul in Mexico lays the foundation and venture into one of the most popular sports outside United States.

· Domestic Growth – Under Armour, Inc. recently announced partnerships to outfit two of the most prestigious collegiate sports programs in the United States, the University Of Notre Dame and the United States Naval Academy. Domestic growth is fueled by steady growth in the direct to consumer sales channel which includes factory house, specialty stores, website and catalog. Contribution from Direct to consumer is growing fast with 30% of the revenue coming from this front in FY 2013. Besides direct to consumer, wholesale contributed 68% and licensing channels contributed 2% to the total net revenues in FY 2013.

· Healthy Living – Under Armour, Inc. recent acquisition of MayMyFitness is going to provide solutions to people to lead a healthy and better lifestyle. At the same time this provides open digital information at the disposal of athletes to help them perform better.

· Foray into new frontiers – Venture into new areas and frontiers including launch of UA performance gold shirts with same performance properties as football. Running, Golf and Outdoor are big business categories which are going to drive growth for Under Armour, Inc. Under Armour, Inc. is also launching its brand in Brazil and Chile. In the English Premier League, Under Armour, Inc, is in the second year of outfitting Tottenham Hotspur and brand awareness have grew three times with more consumers bring brought into the brand.

· Constant Innovation – Under Armour, Inc. has been on the edge of performance apparel and footwear and is evident in the multiple product launches each year. Recent launch of SpeedForm™ Apollo footwear for running and ArmourVent® apparel in 2014. 2013 product launches include UA HEATGEAR® Sonic apparel, UA Spine Venom running footwear and ARMOUR39™ fitness monitoring and tracking system.

Constant humming of the innovation mill, premium brand pricing, more consumer awareness and international expansion will keep Under Armour, Inc. performing in the quarters and years ahead. With a 5 year consolidated return of more than 1000% we think that the growth story at Under Armour, Inc. is far from over.

Competition & Peer Group Analysis

Competitors in this space include Nike Inc. (NYSE: NKE), Adidas AG (ADR) (OTC: ADDYY) and Columbia Sportswear Company (NASDAQ: COLM). Table 1 shows some of the financial metrics for Under Armour, Inc. as well as its peer group competitors.

From this table it is clearly evident that although UA is smaller than some of its competitors it is growing at a much faster pace and hence demand a premium in terms of its share price than any of its competitors. This is evident from the latest quarterly revenue growth rate which at 36% is way above its competitors. This premium pricing in shares of UA is also reflected in the P/E ratio for UA which at 78 is much higher than any of its competitors. Looking at the PEG (price-earnings to growth) ratio we see that it is clearly above 2 and hence at the current price level we consider UA overvalued. Looking at NKE and COLM we see that both are around PEG=2 or less than 2, i.e. fairly valued (at PEG=2) or undervalued (at PEG <2). Peer group analysis also tells us that both Gross Margin and Operating (EBIT) margin for UA is much better than any of its competitors which are other reasons why UA has performed well over the last few years.

*ttm – Trailing 12-Months

Management Analysis

Under Armour, Inc. was started in 1996 by University of Maryland football player, Kevin Plank who is the current CEO of the company. It started off with a plan of how to provide a compression shirt that can wick perspiration off skin rather than absorb it, so that athletes can remain cool, dry and light throughout the course of a game, workout or practice. Other members of the team include Brad Dickerson, the CFO who has been around since 2008 and Kip Fulks who has been around since 1997. With this deep bench of expertise in the executive management, we think Under Armour, Inc. has an edge over any other company in the performance apparel and footwear business which can take UA further along in its growth trajectory.

Financial Statement and Ratio Analysis

Annual financial ratios across different categories are included in the Financial Ratios table on the first page of this report. In terms of valuation ratios which includes P/E, P/S, P/BV, EV/EBIT and EV/EBITDA we see that all the valuation ratios have consistently increased over the last 3 years (2011, 2012 and 2013) based on the fact that Under Armour, Inc. has consistently beaten earnings estimation. For the end of FY 2013, we think that the valuation for UA is stretched with P/E at 58.07 and EV/EBITDA at around 27.

In terms of Profitability Ratios we have seen earlier that the latest FY 2013 displayed better Gross Profit Margin, Operating Margin and Net Profit Margin than the prior year(s). Although it needs to be noted that ROA (Return on Assets) and ROE (Return on Equity) has gone down slightly in FY 2013 as compared to FY 2012.

Solvency Ratios for Under Armour, Inc. indicates that it has been able to retire long term debt obligations from its balance sheet. This is reflected in the lower Debt-to-Assets and Debt-to-Equity ratio as well as higher Interest Coverage ratio. Although long-term debt obligation has been going down both Accounts Payable and Accrued Expenses has been going up at a faster rate (Exhibit 5).

From the Cash Flow Statement (Exhibit 6) it is seen that for Q1 2014, Accounts Receivable has had a huge growth from the prior Q1 2013 period which is not healthy and which means that UA is either not strict with cash collection or loose with its credit terms. This resulted in negative operating cash flow in Q1 2014. Cash and Cash Equivalents at the end of Q1 2014 was $180 million.

Model Valuation

We have used Free Cash Flow to Equity (FCFE) model for intrinsic Discounted Cash Flow valuation of Under Armour, Inc. Following are the assumptions used for the model:

1. Net revenues growth of 20% from FY 2014 – FY 2017 before falling down to a more normal growth of around 5%. Management has been guiding growth of 22-24% but we would like to be conservative in our growth estimates.

2. For Gross Profit, SG&A and Effective Tax Rates we have used the average of the last two periods, e.g. for quarterly estimates/projection we have used the previous two same quarter (e.g. for June 30, 2014 we have used June 30, 2013 and June 30, 2012 values) average values.

3. Other variable components have been kept constant and one-time items have not been included.

We arrive at a Total Enterprise Valuation of $3.66B based on our growth estimates and a stock price of $16.85 (Exhibit 9) which is way below the current market price of $59.49 (as of June 30, 2014). We feel that the current price of $59.49 fully reflects the intrinsic valuation and growth expectations embedded in the UA stock. Hence we are neutral on Under Armour, Inc. (NYSE: UA) with a HOLD recommendation.

Exhibit 1 - Historical Quarterly Income Statement(s) [Mar 31, 2012 – Mar 31, 2014]

Exhibit 2 - Historical Annual Income Statement(s) [Dec 31, 2010 – Dec 31, 2013]

Exhibit 3 - Under Armour, Inc.: Revenues & EBIT Growth by U.S. Domestic & International (Foreign) (Quarterly & Annual)

Exhibit 4 - Historical Balance Sheet(s) [Mar 31, 2012 – Mar 31, 2014]

Exhibit 5 - Historical Annual Balance Sheet(s) [Dec 31, 2010 – Dec 31, 2013]

Exhibit 6 - Historical Quarterly Statement of Cash Flows [Mar 31, 2012 – Mar 31, 2014]]

Exhibit 7 - Historical Annual Statement of Cash Flows [Dec 31, 2011 – Dec 31, 2013]

Exhibit 8 - Quarterly & Annual Earnings Projections

Exhibit 9 - FCFE Model Valuation of Under Armour, Inc.

Major Players in the Oil & Gas Sector

Major oil shale plays in U.S. include Eagle Ford shale, Bakken shale and the Permian Basin. Continental Resources (CLR) and EOG Resources (EOG) are the primary players in the Bakken shale (Williston Basin/Three Forks and Sanish formations), EOG Resources (EOG) in the Eagle Ford shale and Pioneer Natural Resources (PXD) in the Permian Basin (Spraberry/Wolfcamp formations). Efficient horizontal drilling techniques employed by these Exploration and Production companies is helping them unlock vast oil reserves from these shale formations and driving their massive growth (e.g. 39% 4-Year CAGR for EOG Resources from 2011–2014E[1]) in the last few years.

The picture below shows how EOG Resources is way ahead of others in some of the major shale plays.

Source: http://www.eogresources.com/investors/slides/InvPres_0414.pdf

U.S. based refiners - I like some of the players including Phillips 66 (PSX), Valero Energy (VLO) and Holly-Frontier (HFC) which are my favorite names because of their major refining capacity locations around the Gulf coast for Valero and mid-continent for Holly Frontier. Recent pipeline capacity and railroad expansion to southern Gulf coast is also helping transport crude easily from the major manufacturing shale regions deeper in the country to the refineries at the coast and helping relieve some of the glut from the major oil storage hub at Cushing, OK. Higher differential or spread between Brent -WTI (West Texas Intermediate) crude or Brent – LLS (Louisiana Light sweet) crude will help to boost the margins for the refiners for whom the cost of raw crude is tied to the lower U.S. mid-continent crude prices while their refined end product is sold at higher international Brent prices. The reason for the higher spread include global macroeconomic factors including tensions around Russian oil supply to Europe, domestic issues in Africa, higher demand from China, Japan and rest of Asia, etc. which would keep the international benchmark of Brent crude prices higher. At the same time higher inventory and supply of oil from the major shale plays would keep the WTI prices suppressed.

I see a lot of M&A potential as well in the U.S. based shale oil plays where some of the big Asian (e.g. CNOOC China, etc.) or European players (e.g. Total SA, Royal Dutch Shell, etc.) can easily scoop up some of the U.S. based players having a big foothold in the major shale regions, e.g. Statoil’s purchase of Brigham Exploration (BEXP) in the Bakken shale. The names which I like in this regard (potential M&A targets) include the mid-cap E&P names like Oasis Petroleum (OAS) and Whiting Petroleum (WLL) in the Bakken, Gulfport Energy (GPOR) in the Utica shale and Permian Basin (through ownership in Diamondback Energy) because of consistent execution and growth potential.

The picture below depicts the geological landscape of the Permian Basin.

Source: Tom Fowler, Second Life for an Old Oil Field, Wall Street Journal, Nov 19, 2013.

[1]http://www.eogresources.com/investors/slides/InvPres_0314.pdf