Nike (NYSE:NKE) and Under Armour (NYSE:UA) are both flirting with 52-week and five-year highs. It’s an intense competition for sure. Nike’s stock is up 11% as of Oct. 25, Under Armour an impressive 46%. Both are firing on all cylinders. However, if I had to pick, I’d sell UA stock and buy NKE. Here’s why.
Cracks in the Armour
These aren’t cracks you would necessarily anticipate. Under Armour just came off a strong third quarter during which revenues increased 42% to $465.5 million, and net income 31.8% to $49 million, or 88 cents per share. As a result, it raised its full-year revenue guidance to a minimum of $1.46 billion and operating profits to $159 million. That’s year-over-year growth of 37% and 42%, respectively.
What’s not to like? Its nascent footwear business grew 96.7% in Q3, to $52 million. Apparel revenue grew 31.3%, accessories 210.2% and direct-to-consumer 73%. Its factory outlets and e-commerce now account for 22% of overall revenue, and that figure is rising. By the end of 2011, Under Armour will have 80 factory house stores open; another 16 to 20 will open by the end of 2012. About the only thing that isn’t growing is the company’s licensing revenue, which declined 17.8% in the quarter, to $10.4 million. It’s a very small part of the company’s overall business and not a concern.
Under Armour’s business is fundamentally sound, no question. However, this is an argument about which stock to own. Nike is the 1,000-pound gorilla to Under Armour’s church mouse. Growing globally and expanding its direct-to-consumer business at the current pace raises questions about whether Under Armour will be able to keep a lid on costs. In the third quarter, UA’s gross margin shrunk 250 basis points, to 48.4%, and its operating margin declined 120 basis points, to 16.1%. Revenue outside the U.S. accounts for just 7% of overall sales.
Moving the needle on this front is going to take increased marketing and sales expenditures. In the third quarter, Under Armour’s marketing expenses increased 36% year-over-year, to $48.4 million. With 93% of its revenue in the U.S., it’s able to leverage those costs. It won’t be able to do that as easily overseas. Expect marketing costs to increase substantially.
The same holds true for Under Armour’s factory stores. Hibbett Sports (NASDAQ:HIBB), a retailer of Under Armour merchandise, spends approximately $181,000 to build out a 5,000-square-foot store. That’s $36 per square foot. I’d guess that Under Armour spends at least double that amount to open its stores. If it attempts store openings outside the U.S., expect this number to double again. The big question isn’t whether Under Armour can grow. It’s whether it can do it profitably.
Inventory growth outpacing revenues is something that’s dogged the company for years. In the third quarter, inventory grew by 63% year-over-year compared to 42% for revenues. It’s not hurting the company at the moment, but it will if its business stalls. Priced for perfection, any slip-up will immediately result in a 25-50% dip.
Just Doing It
You can pay almost eight times book for UA or take a pass and pay 4.4 times book for NKE instead. What do you get for that? Operating margins approximately 30% higher despite lower gross margins, a mature company that still managed to grow revenues in the latest quarter by 18% and profits by 15%, and a Chinese business that’s just getting going.
Although Nike has been operating in China for 30 years, it hit only $1 billion in revenue in 2007. A second billion dollars in revenue came just four years later. Nike management expects to generate $4 billion by May 2015. Unless China’s economy seriously slows, I see it blowing past this number.
All the heavy lifting Nike has been doing over the past 30 years is now paying off, while Under Armour barely has gotten on the field. Why pay a dear price for a company you know is going to have serious cost containment issues going forward when you can own a business that’s already built the global infrastructure necessary to be the world’s best sports business? What’s more, with Nike you’ll receive more than $1 in dividend income annually.
Bottom Line
Under Armour founder and CEO Kevin Plank’s story is a good one, as is his company. However, I’m only interested in owning stocks at a reasonable price. Going head to head, Nike easily wins this race.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.
