Under Armour: Growth You Better Believe In

There are many reasons to invest in a company, all boiling down to purchasing something at a discount to its intrinsic value. In Value Investing: From Graham to Buffett and Beyond, author (Columbia Business School professor) Bruce Greenwald succinctly explains the possible components of intrinsic value, beginning with the value of the company’s assets, then layering in a no-growth earnings power valuation, and ultimately adding in franchise (and growth) value. As we move up through the layers, valuation becomes more nebulous and consequently more risky (i.e. it is easier to ascertain a discount to the company’s NCAV than it is to have confidence in potential future growth which may or may not materialize).

Let’s look at the case of Under Armour, Inc. (NYSE: UA) the branded apparel company.

First we’ll start with assets. The company derives value almost purely from its brand, in that it outsources virtually all of its manufacturing and sells through a retail network of 23,000 locations worldwide (just 54 of which it owns). (One scary consequence is that the company relies on just two retailers, Dick’s Sporting Goods (DKS) and The Sports Authority, for more than 1/4 of its sales.) As a result of this strategy, one might expect a relatively greater emphasis on working capital rather than PP&E and other long-lived tangible assets. Not to disappoint, UA reports just $90.7 million in PP&E versus total assets of $766.2 million. The bulk of the company’s assets are cash, accounts receivable and inventories. This is a good thing, as these assets are easier to value than something like “Intangible Assets” or “Goodwill.” Speaking of intangibles, it is nice to see that UA has developed its brands in-house rather than through acquisitions, as the company reports a paltry $3.45 million of intangibles, or less than a half a percent of total assets (compare to Nike (NYSE: NKE), which has 10x as high a proportion of total assets in the form of intangibles).

Unfortunately, on an asset basis alone the company’s current valuation is difficult to justify. The company reports book value of equity at $538.5 million versus a market capitalization of $3.8 billion. As mentioned, the company appears to develop its brands in-house, so the full value of these brands is not accounted for in the current book value. However, if you assume for argument’s sake that ALL of the company’s SG&A for the last seven years went toward developing the brands, this would still only amount to an additional $1.567 billion, meaning that you would only be 55% of the way to the current market cap. Surely there has to be something more to justify the premium.

A company can trade at many times its book value if it is able to generate earnings from its assets far in excess of what others can. Imagine the only cold water dispenser in the middle of the desert. You would expect shareholders of that asset to be enjoying returns far in excess of what the same asset would earn in say, a suburban Florida mall, thus a premium to book value would be justified (Combine returns and book value by completing a Residual Income Valuation).

Let’s look at UA’s returns.

Under Armour, Inc. - Returns, 2004 - 2Q 2011