4 Reasons To Avoid Under Armour Inc. Stock

Shares of Under Armour (NYSE: UA) (NYSE: UAA)recently plunged to multi-year lows after the footwear and apparel maker posteda big fourth quarter earnings miss and dismal guidance for the first quarter. Revenue rose 12% annually to $1.3 billion, but that missed estimates by $100 million and was much lower than the 20%+ growth it had continually posted for over six straight years.

Under Armour spokesman Steph Curry. Image source: Under Armour.

On the bottom line, Under Armour's diluted earnings fell by a penny to $0.23 per share, which missed estimates by two cents. Its gross margin fell 320 basis points annually to 44.8% primarily due to competitive pressure, inventory management expenses, and currency headwinds.

For the current quarter, Under Armour expects its revenues to riseat a "mid single-digit rate" due to continuing weakness in North America and unresolved expenses from the Sports Authority bankruptcy last year. Analysts had expected its first quarter revenues to rise 23% annually. For the full year, UA expects 11%-12% revenue growth, compared to 22% growth in 2016.

Contrarian investors might think Under Armour's big drop represents a good long-term buying opportunity. But I believe that the stock still has a lot of room to fall, for four simple reasons.

1. It's just another apparel and footwear retailer

Under Armour founder and CEO Kevin Plank has repeatedly claimed thathis company's high tech fabrics, mobile apps, and wearable devices make it more of a tech company than rivals Nike (NYSE: NKE) and Adidas (NASDAQOTH: ADDYY). But the simple truth is that the company's Connected Fitness (apps, wearables, and connected gadgets) business generated less than 2% of its 2016 revenues.

Apparel revenue accounted for 67% of its top line, footwear revenue accounted for 21%, and accessories revenue accounted for 9%. Under Armour's dependence on footwear has risen over the past few quarters, which is troubling because it's forced the company to compete more aggressively against Nike and Adidas in marketing and sponsorship pushes. But even big sponsorships can't offset lackluster designs -- as UA learned when the Curry 2's "nurse shoe design" waswidely lambasted online.

Image source: Under Armour.

2. The return of Adidas

Adidas was stuck in neutral over the past few years as its brand strength faded and its cash flows were sapped by its money-losing acquisition ofReebok. But in mid 2015, Adidas unveiled an ambitious five-year turnaround plan to accelerate its annual sales growth to the high-single digits on a constant currency basis. That plan included the faster production and rotation of products, aggressive expansion in urban markets, higher investments in e-commerce, and increased engagement campaigns with consumers, retailers, and partners.

That turnaround plan has been crushing expectations. Adidas' currency neutral sales rose10% in fiscal 2015, compared to 6% growth in 2014 and 3% growth in 2013. Sales rose another 15% inthe first nine months of 2016. When we compare that growth to Under Armour's slowdown, it's easy to see that Under Armour is likely losing customers to Adidas.

3. Rising inventories, shrinking margins

Under Armour's year-end inventories rose 17% from 2015 levels, partly due to the Sports Authority bankruptcy. To flush out all that excess inventory, the company will likely need to slash prices. To promote new products, it will need to boost its sales and marketing expenses. That costly combination will put a lot of pressure on UA's operating margins, which already dropped to the single digits last year.


4. It's still very expensive

Under Armour still trades at about 48 times trailing earnings. That's much higher than Nike's P/E of 24 and the industry average of 27 for apparel makers. That high multiple also isn't justified by analysts' projections for just4% earnings growth this year. UA's earnings growth is expected to accelerate to 19% in fiscal 2018, but that forecast could be too bullish considering how bleak its recent guidance was.

Even if we assume that Under Armour can meet analyst expectations to grow its annual earnings at an average rate of 21% over the next five years (which likely needs to be adjusted downwards), that growth trajectory gives it a 5-year PEG ratio of 2.2. Since a PEG ratio under 1 is considered undervalued, UA looks pricey relative to its earnings growth potential. By comparison, Nike has a 5-year PEG ratio of 1.9, which is based on a projected 5-year annual earnings growth rate of 12%.

Don't fall in love with this stock

I believe that some investors have fallen in love with Under Armour's growth story, the underdog that challenged industry giants like Nike and Adidas. Looking ahead, some bulls still believe that UA's overseas expansion can offset its slower domestic growth, or that it can eventually raise prices to boost margins.

But as we saw with Under Armour's disastrous fourth quarter numbers and 2017 guidance, those tailwinds probably won't pick up anytime soon. Instead, the company's next few quarters will likely feature slowing sales, deteriorating margins, and the loss of customers to better-funded titans like Adidas and Nike. Therefore, investors should look elsewhere for better bargains in the brutally tough retail industry.

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Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Nike, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool has a disclosure policy.