With an unfriendly Fed, rising and excessive federal and corporate debt, and tepid corporate earnings, investors are overlooking a great deal to keep stocks trading near record highs. Then again, when investors are no longer sentient beings but machines and park-your-brains-at-the-door ETFs, economic and corporate fundamentals don’t matter, only sentiment and momentum.
Investors poured $426.1 billion into domestic ETFs over the past 12 months (through the end of February) including $44 billion in February alone (and $62.9 billion into global ETFs in the shortest month of the year), raising the total to $124 billion for the first two months of 2017. There is now roughly $2.8 trillion invested in U.S. ETFs (see the image below, which shows the year-over-year growth).
Just to be clear, what this ETF bubble means is that nobody ever has to buy an individual stock again or perform the fundamental research required to make that kind of investment decision because the ETFs will do it for them without doing that fundamental work. That explains how a no-growth company like Kellogg Co. (NYSE: K) can trade at a 20x P/E or Exxon Mobil Corp. (NYSE: XOM) can trade at a 44x P/E (because they are owned by dozens of ETFs).
Or the company I’m about to show you – which is owned by no fewer than 52 ETFs and is trading at a ridiculous 41.5x earnings.
Incidentally, it’s also headed straight to hell in a handbasket…
Heavy ETF Ownership Can’t Prop UAA Up Much Longer
Maybe it’s the contrarian in me, but whenever I see a company touted on the front page of Barron’s or another business magazine, I smell blood.
Especially when the company’s stock has fallen 55% in the past year and is still trading at a ridiculous 41.5x earnings. The last thing investors need is another retail turnaround story but that’s exactly what they have in Under Armour Inc. (NYSE: UAA). The stock has collapsed from its 52-week high of $46.20 and even Wall Street analysts, which hate to put a sell rating on anything, are downgrading this once beloved name. Facing monster competitors like Nike Inc. (NYSE: NKE) and Adidas (ADS Germany) (UAA has about $5 billion in annual sales compared to NKE’s $34 billion and ADS’s $21 billion), UAA is going to have a tough time getting its act together and shedding its reputation as the single worst performer in the S&P 500 over the last year. I’m betting things will get worse before they get better – they usually do and in the current retail carnage, they definitely will.
One of the reasons the stock collapsed was that it was trading at a ridiculous multiple in the first place. The only thing worse than an overvaluation story is an overvaluation story in an industry that is getting battered by structural headwinds like retail. Over the last five years, UAA traded at an average of over 50x forward earnings. But even after falling 55% over the last year, the stock is still trading at 41.5x projected earnings! So very little has changed except investors have gotten their clocks cleaned and are sitting on a stock trading at twice the market multiple. And that market multiple of 22x GAAP earnings is too high, but that is a discussion for another day. The point is that UAA is a grossly overvalued stock on a good day, and the company is not having good days. Let’s take a look.
A Series of Bad Decisions Make Under Armour an Uncomfortable Fit
UAA reported 4Q16 EPS of $0.23 per share, lower than expected. Revenues came in light as a result of retail bankruptcies (which are going to be an ongoing occurrence); lower traffic, which led to promotional activity (i.e. discounting); and product misalignment, a polite term for offering products that consumers don’t want. International business grew but North American business growth fell to only 6% which won’t do for a company trading at such high multiples. EBIT (earnings before interest and taxes) margins contracted by 250 basis points to 12.7% (and are approaching half what they were in 2015) and gross margins shrunk by 320 basis points to 44.8% as inventory issues, product mix and foreign currency headwinds hit profitability. SG&A increased by 70 basis points to 32.1%. The bottom line is that the company is having trouble managing its growth and is being hurt by the serious problems occurring in the retail space, especially mounting retail bankruptcies.
UAA recently entered into a new deal to sell its products in Kohl’s Corporation (NYSE: KSS), another dying brick-and-mortar retailer. Recent channel checks showed that Kohl’s was discounting Under Armour items by 25%, which is hardly surprising considering that Kohl’s has its own problems attracting consumers to its tired stores and is competing with other tired retailers like Target Corporation (NYSE: TGT), J. C. Penney Company Inc. (NYSE: JCP), Macy’s Inc. (NYSE: M) and countless other dying traditional stores. Under Armour is selling the same items at Kohl’s that it is selling at sporting goods chains Dick’s Sporting Goods Inc. (NYSE: DKS) according to channel checks, particularly tops and leggings (that lately, apparently, can now get you kicked off airplanes by uptight gate agents!). The Kohl’s deal seems like an odd choice for expanding the brand, but UAA management has not distinguished itself recently and this may well prove to be another blunder.
UAA has an anti-shareholder rights two-class share structure that gives total control of the company to founder Kevin Plank and stands sharply in contrast with its image as a consumer friendly company. Class A shares (UAA) come with one vote apiece. Class C shares (US) were issued in 2016 and have no votes. There are also B shares with 10 votes apiece that are owned solely by Plank who is obviously not interested in shareholders rights or norms of corporate governance. There is no place for such a share structure in today’s day and age and anyone willing to buy shares that have no rights attached to them needs to have his or her head examined. Buying those shares at twice the market multiple makes you a candidate for institutionalization.
While Barron’s cover article was trying to pump up UAA stock, a careful reading of the article showed many more negatives than positives. It is very difficult to turn around any company whose stock has entered a tailspin, particularly one in an industry as troubled as retail is today. I expect things to get worse for UAA before they get better. If you own the stock, sell it. If you would like to consider some long-dated puts, that would also be a smart move.
Zenith Trading Circle subscribers, as always, can get my full, detailed recommendation here.