On Under Armour (UA)... Am I Crazy?

I am back from personal issues and will devote some significant time to my thoughts on the market and individual stocks.

I am currently focused on Under Armour (UA) as a play into earnings next Tuesday, July 31, 2007. Many poignant arguments made by the shorts have validity regarding Under Armour. For example, many "shorts" would be quick to point out that the stock cannot justify the high PE of 60+ especially when the analysts have this stock pegged to grow 25% year over year for the next five years. Additionally, many question the margin pressures eroding earnings due to competition from NIKE (NKE), ADDIAS, and PUMA. Furthermore, last quarter's earnings dampened excitement and confidence on the current management's ability to deliver high octane growth parameters to continue to justify the sky "high" valuations of this company. The company continues to burn money into advertisements and endorsement deals and many question this "up front" payment for future growth would be sustainable. Yet, the company has not signed on any "high power" athletes to any endorsement deals. Nike burst onto prominence as the preeminent sports apparel and footwear company when they were able to lock in endorsement deals with Michael Jordan (Air Jordan lineups), Tiger Woods, and catchy slogans as "...Just Do It". The management was able to deliver quite thrilling returns on investment to its shareholders and today continues to hold the reign as the "king" of sports apparel.

So, how can Under Armour (UA) compete with the likes of Nike (NKE)? What forms of competitive advantage does this company have to justify its high PE, stiff competition, and lack of strong endorsements from star athletes? And am I crazy to be bullish on the prospects of this stock?

I would like to take into consideration major points of "short" thesis on why this stock is "overvalued" and offer some correlary to their argument.

1. High PE is not Justifiable: Under Armour (UA) has a high price to earnings ratio, there is no denying that fact. When the average peers in this industry is trading at an average PE ratio of 19.9 with PEG average of 1.29 and UA is showing a PE of 64.07 and PEG of 2.47, certainly I would agree that Under Armour, Inc (UA) is not cheap by any stretch of the imagination. But at the same time, that is not the central thesis of this stock. It is and never will be a value play. Whereas Nike (NKE) is a mature business with market cap that is over 10X Under Armour's (UA) and Revenue that is 4X, Under Armour is a new company with an upstart competitive advantage in their fabric technology. The technology behind Under Armour's diverse product assortment for men, women and youth is complex, but the program for reaping the benefits is simple: wear HeatGear® when it's hot, ColdGear® when it's cold, and AllSeasonGear® between the extremes. These technologies are unlike any other fabrics currently offered by its competitors and it shows in the quick rate of adoption by professional, collegiate, semi-professional, and youth sports organizations. In short, UA has a technological innovation that is difficult to copy AND offers performance enhancement unlike any other offerings that are out in the market place today. Based on this technology, a high PE ratio can be justified, especially in a company that is nary 2 years old and is managed by a visionary leader Kevin Plank, who understands competitive sports (he was a former University of Maryland football player).

2. Shrinking Margins: This is perhaps the most recited quote from "shorts" regarding UA. Under Armour is not showing any margin contraction. it did have a one time hiccup last quarter, mostly due to high expenditures related to heavy advertisements and marketing initiatives. A one time hiccup is allowed and this company is still young and is feeling its way through the intense jungle of competition. It is winning in many fronts. One needs to just stop any school aged children or watch professional football, soccer, base ball, and collegiate sports to see the ubiquitous nature of this brand. There is a type of cult following by the athletic community. One only needs to try on one of the "over priced" pair of work out gear to realize, it really is different for the better. I doubt highly that the margins are shrinking and for those that are counting on continued down cycle of gross margins will be mistaken. One aspect that many seem to forget is that while UA is priced higher than its competitors, people will generally pay for quality, style, and performance. I believe that is the case here. So gross margin contraction should not be an issue.

3. Stiff Competition: Show me any industry that is without "stiff" competition and I will kiss your feet. The fact remains, is that UA has a distinct and unique product in their fabric construction that makes them favorable over the other brands offered by its competitors. I would also say that they have won the image wars between NIKE and Addidas as it has become a fashionable statement to wear Under Armour. They are performance enhancing and cool. I do not believe that UA is losing on this front.

4. Weakening Consumers: This is one area of concern especially with all the subprime fallouts and forecasts of doom and gloom. However, I do not believe that the American consumers are dead. I believe that the American consumers are savvy an will pay a little more for quality, comfort, and value. Under Armour does offer value in a sense that their apparel feel better. It is not like they are gigantically over priced either.

My take is that with short interest north of 40% currently and that the expectations have been diminished by previous quarter, I would lend caution to the wind to the shorts and say that it may not take much to generate a significant short squeeze come earnings time.