Beware of Any Disappointment

 | Oct 27, 2011 | 9:30 AM EDT
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On Tuesday Under Armour (UA) reported third-quarter earnings per share of $0.88 -- $0.05 ahead of expectations -- on a 42% increase in revenue. The company upped sales guidance to between $1.46 and $1.47 billion, up from the prior range of $1.42 to $1.44 billion. Momentum investors broke out the bubbly as the stock jumped higher on the good news. Can Under Armour really sustain this kind of momentum, or are investors going to end up under water?

According to NPD Group, the footwear and apparel business grew just 1.9% in 2010 and 0.7% in the first half of 2011. Last year, specialty apparel was the second-fastest-growing part of the industry, posting 6% growth over last year. (Factory outlet apparel was the fastest, growing 12%.) More specifically, according to the Sports Goods Manufacturing Association, the sports-apparel market is estimated at $30 billion wholesale in 2010 and grew 4.8%, slightly lower than the specialty business.

However, UA has outperformed the rest of the industry. In fiscal 2002 the company had just $49 million in revenue, and a decade later the estimate is $1.46 billion. The company believes it can get to $2 billion in revenue by 2013. But it hasn't always been a smooth ride.

If you recall, back in April the company reported that first-quarter revenue rose 36% year over year, but inventories jumped 68% and gross margins dipped to 46.4%.  Then, in July the company reported that second-quarter margins fell 250 basis points. In both cases, the stock was punished despite the higher revenue growth. In particular, the company's direct-to-consumer business -- which generates 22% of revenue -- grew 73% year over year. Accessories and footwear blew the barn doors off, rising 211% and 97%, respectively.

The company introduced a line of football cleats in 2006 and followed up in 2007 with a line of softball cleats. In 2009, the company further expanded the footwear line to include performance training, running and, most recently basketball.

I guess my big concern with Under Armour is valuation, as the stock is trading at 45x analyst estimates and has been very difficult to short. One recent phenomenon we've seen has been the lack of short sellers. If the company disappoints, there could be a substantial drop in the shares, since a lot of short sellers have been chased out of the market and there isn't anyone left to buy on the way down. The stock dropped 38% in August on disappointing results. Investors in Under Armour should be careful, as any disappointment could leave them underwater.



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