3 Reasons to Avoid Under Armour Stock

Peter Lynch said, "Never fall in love with a stock; always have an open mind." By the middle of 2016, Under Armour (UAA -0.95%) (UA -1.05%) achieved an impressive milestone of 25 consecutive quarters with at least 20% revenue growth. Investors fell in love with the stock, at about the time the growth story started to come apart at the seams. Shares that previously traded around $40 spent much of 2020 in the $7 to $12 range. Prior to the athletic apparel maker's latest earnings, the shares appeared ready to break through the $12 ceiling before losing momentum. The company's brand doesn't seem to resonate as "premium" with customers. In addition, Under Armour is still spending money, and carrying excess inventory, like a growth company without the growth.

1. Tailwind or a passing breeze?

Prior to Under Armour's last earnings, Raymond James analyst Matthew McClintock said, "low valuation, strong brand, and favorable position in the broader athletic industry are potential tailwinds for Under Armour." Right after earnings, Susquehanna Financial Group analysts led by Sam Poser openly questioned whether Under Armour should be considered a premium brand. The company's lack of a clear brand image is the first reason to avoid the shares.

Image source: Getty Images.

According to Susquehanna, in order for Under Armour to improve its brand positioning, the company needs to cut ties with moderately priced retailers such as Kohl's and TJX Companies (think T.J. Maxx and Marshalls). Instead, the analysts say Under Armour should focus on retailers such as Dick's Sporting Goods and Hibbett Sports. On the surface this sounds like a decent plan, but Susquehanna also noted that Under Armour sales are "floundering" at these higher-end retailers.

The pandemic has negatively affected many retailers including Under Armour and its peer Nike (NKE 0.12%). However, as Patrik Frisk, CEO of Under Armour, pointed out on the Q2 2020 conference call, "China that is really two months ahead of the curve over the rest of the world." He also said, "the traffic levels are still not back to where they were before."

This comment stands in stark comparison to what Nike experienced during the same time frame. Nike CEO John Donahoe said that monthly active users of Nike's Trending app increased more than 350% since the beginning of 2020. The increase in users resulted in Nike's China business returning to growth in the fourth quarter. With Under Armour facing brand challenges domestically, and underperforming in China compared with Nike, it's difficult to see the stock breaking out to the upside anytime soon.

2. Spending like it's 2015

In 2015, Under Armour was a growth stock and investors were happy to be along for the ride. Investors are usually OK with fast-growing companies spending on expansion if revenue grows faster than their industry or the market overall. Where fast-growing companies run into trouble is when they continue to spend like they are in fast-growth mode, yet their revenue can no longer keep up.

This brings us to the second reason investors should avoid Under Armour: The proper management of selling, general, and administrative (SG&A) expenses is core to running a successful business, and Under Armour has some work to do. The company's SG&A expenses came in at nearly 68% of revenue in the last quarter. By point of comparison, Nike's SG&A percentage was 50.5%. If Under Armour was less efficient for one quarter, investors could possibly ignore the issue, but this isn't a short-term challenge.

Data sources: Nike and Under Armour. *Nike uses FY 2020 and FY 2019 to represent calendar years 2019 and 2018 respectively.

With Under Armour consistently spending a higher percentage on SG&A than Nike, it seems management could do a better job of controlling expenses. In fact, SG&A isn't the only item that Under Armour management needs to get a better handle on.

3. The 800-pound gorilla is back

The third reason to avoid Under Armour stock is the company's 800-pound inventory gorilla is back. Last August, on a Motley Fool podcast, MFAM  Funds CIO Bryan Hinmon said, "Under Armour had suffered for years from basically poorly managing its own inventory and flooding the market, which hurts the brand and causes them to have to cut prices." He also noted that CEO Frisk was focused on improving inventory management.

Data sources: Nike and Under Armour.

If this were the end of the story, Under Armour would still be at a disadvantage but getting better relative to its peer. However, Nike and Under Armour's current quarterly results suggest the latter may be moving in the wrong direction again. Under Armour carried 169.5% of inventory relative to current quarterly sales. Nike on the other hand, had 117.5% of inventory compared with current-quarter sales.

The problem is how each company plans to solve its abundance of inventory. Nike CFO Matthew Friend said, "we are confident that Nike inventory will be rightsized and in a normal position in Q2." In the meantime, Under Armour said it expects the rest of the year will be, "undoubtedly punitive to our top line given an expectation of higher discounting and promotions across our space in the second half of the year." Each company seems to have a plan to get inventory under control over the next six months, yet the devil is in the details.

Nike's Donahoe said, "our discounting is less than what we're seeing across the broader marketplace." The company also said its strong brand is allowing Nike to move through inventory faster than the rest of the marketplace.

The bottom line is that Under Armour has brand challenges, spends relatively more on SG&A than its peer, and carries more inventory. This once fast-growing stock has stagnated recently, and its challenges aren't quickly solvable. Unless Under Armour can solidify its brand and improve its financials, avoiding the shares is likely the best course of action.