Play the Contrarian And Buy the Dip in Under Armour Stock

UAA stock could be a good "buy the dip" candidate after the recent post-earnings plunge

Shares of Under Armour (NYSE:UAA) plunged in early February after the struggling athletic apparel maker reported mixed fourth quarter numbers that included a dismal 2020 guide. Of note, while Under Armour’s profits in the fourth quarter matched analyst expectations, management guided for just 13 cents in earnings per share in 2020 (at best), versus a consensus sell-side estimate of 46 cents.

That means Under Armour projects to earn less than 30% of what Wall Street thought the company would earn this year. Investors naturally freaked out in response, and UAA stock fell by 20% to its lowest levels in over a year.

At this point in time, I think it’s smart to play the contrarian and buy the dip in Under Armour stock.

My rationale is simple. First, Under Armour’s fundamentals are bad but not awful, and the company should keep growing. Considering that reality, shares seem undervalued here.

Second, the stock has formed formidable technical support at the $16 to $17 range over the past few years, and shares are presently closing in on those levels. And third, a big portion of the sell-off has to do with coronavirus anxiety, which ought to subside in the coming months.

All in all, I like Under Armour stock on the dip. Over the next few months, I expect shares to find support around $16 to $17 and rebound back above $20.

All is not Lost

Under Armour’s fourth quarter earnings report was bad and 2020 guidance was even worse. But all is not lost, and there are still plenty of things to like about this company.

Sure, revenues rose just 4% in the fourth quarter, and are expected to drop by roughly 2% next year. That’s not good. But Under Armour is still one of the four major players in the athletic apparel market, alongside Nike (NYSE:NKE), Adidas (OTCMKTS:ADDYY) and Skechers (NYSE:SKX). That market remains supported by secular adoption tailwinds. Granted, those tailwinds are stronger on the lifestyle side of the market, and less strong on the performance side (where Under Armour operates).

Nonetheless, revenue erosion is unlikely to last beyond 2020, and market tailwinds coupled with easier laps will bring positive revenue growth back next year.

Below the top-line, things actually aren’t so bad. Gross margins rose by 230 basis points in the quarter amid supply chain enhancements and lower discounting. They are expected to rise another 40 basis points next year for the same reasons. Concurrently, while opex rates are rising, that’s mostly because of sluggish revenue growth. Expenses rose just 2% in 2019. Continued moderate expense growth plus gross margin expansion lay the groundwork for profits to roar higher once revenue growth turns positive again.

All in all, then, Under Armour is just getting stung by some near-term demand headwinds. These demand headwinds won’t last. Once they pass, Under Armour will return to being a low single digit revenue growth and double-digit earnings growth company.

Under Armour Stock is Cheap

At current levels, there are two big things to like about Under Armour stock.

First, the stock is cheap relative to the company’s realistic earnings growth prospects. After this year, Under Armour should return to and sustain low single digit revenue growth, thanks to broader athletic apparel market tailwinds. Gross margins will keep moving higher as the company starts selling more into full-price channels and eases on discounting. Operating expense rates will compress as management maintains a ~2% expense growth rate.

Putting all that together, from this year’s projected 13 cents earnings per share base, Under Armour’s profits will likely rise towards $1.25 by 2025. Based on an apparel retail sector-average 23-times forward earnings multiple and a 10% annual discount rate, that implies a 2020 price target for the stock of nearly $20.

Second, the stock will find powerful technical support in the $16 to $17 range. Since early 2018, Under Armour stock has bottomed out at these levels several times, namely in April 2018, October 2018, December 2018, August 2019 and November 2019.

It is fairly likely that shares once again find support at these levels. If they do, that means the worst of this sell-off is over, and the stock is due for a relief rally over the coming months.

Bottom Line on UAA Stock

Under Armour is struggling. These struggles will continue, but the valuation on Under Armour stock is cheap, and shares are running into multi-year technical support levels. As such, it makes sense to start buying the dip in Under Armour stock here. Over the coming months, it’s quite likely that shares stabilize around $17 before popping back to $20.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.