In early April, prior to Under Armour’s (UA) Q1 results I took a quick look at the trade set up with the stock in the mid $40s (here), and touched on one of the pillars of the bear case for the stock:
I suppose the problem for some when it comes to UA is the fact that the stock trades 130x expected 2016 earnings, but I suspect most long term bulls are more focused on the company’s mid 20% sales growth expectations for years to come, and the fact that only 10% of the company’s $4 billion 2015 sales came from outside the U.S. The stock’s high short interest is reflective of investor’s concern about valuation, and their ability to meaningfully take market share from Nike (NKE), but I suspect that while the bull story does not hinge on future success of sponsors like Curry and Spieth, their continued success might be the thing that causes investors to look past such mundane things as triple digit P/E ratios.
Following results, the stock did breakout of its 2 month consolidation, but very quickly gave up the gains, and then some, just this morning trading at 2 month lows, down 22% from its post earnings highs, and down 33% from its all time highs made last year:
UA seems to have some technical support between $34 and $36, but as the 5 year chart below shows, the uptrend from 2011 is broken, and the February lows is crucial support:
SO why the relative weakness over the last month? Whenever this stock sells off, valuation is always one of the first words out of anyone’s mouth. On the playing surfaces was it Jordan Spieth’s high profile meltdown in the final round of the Masters? Doubt it, as Steph Curry’s 2nd consecutive NBA MVP should have more than covered for that. Maybe recent management shakeup is weighing… but I suspect it has something to do with the fact that prior market leaders like Costco (COST), Walt Disney (DIS), Nike (NKE) and Starbucks (SBUX), all that traded at premium valuations to their peer group and the market, have lagged of late.
When I think about UA, with a $15 billion market cap, and expected 2016 sales of $5 billion, expected growth of 27%, and only about 10% of those sales to come from outside the U.S., I can’t help but imagine their ability to grow sales 20% plus for years to come. On the flip-side, NKE is expected to have $32.5 billion of sales in fiscal 2016, growing 6% yoy, sporting a $96 billion market cap. So UA has about 15% of their sales, and 15% of their market cap, I see no reason why this company should not continue to grow both here and massively abroad in the coming years, regardless how much is taking share from NKE.
Between now and that time in the future where the company demonstrates the potential for uber growth in markets like China, the road might be a tad bumpy, because of their lumpy valuation. There are two ways I would look to play this with an eye towards the stock rallying in the back half of the year.
So What’s the Trade?
First, you could define your risk to a wide range using a risk reversal. For instance with the stock at $37.20, you could sell the Jan17 30 put at $1.80 and buy to open the Jan17 45 call for $1.95, resulting in a 15 cent debit. Between 30 and 45 on Jan17 expiration you would lose just the 15 cents premium you spent. The worst case scenario is being put 100 shares of stock per 1 put sold short at $30, down about 20% from current levels. At $45.15 or higher you would have gains as if long 100 shares per 1 call. This trade structure offers a wide break-even to be both the upside and downside, does not limit gains and offers leverage to upside move with minimal initial premium outlay. It is important to note that naked short puts may require similar margin requirements to long stock and that on a mark to market basis you will have losses as the stock moves closer to the short put strike, and gains as it moves closer to the long call strike.
But we like the idea financing long dated, slightly out of the money calls via a call calendar:
*UA (37.20) Buy the June/Jan 40 call calendar for 3.00
- Sell 1 June 40 call at .55
- Buy 1 January 40 call for 3.55
Rationale – The idea here is to sell calls in an expiration before the next catalyst. The company’s Q2 earnings will fall in Aug expiration. If the stock is still below 40 on June expiration that means we can roll the short call another month and still not catch August earnings. That means we can get through most of the Summer whittling down that upside exposure in January. Ideally the stock creeps higher into June expiration with the ideal situation being at or near 40. The max risk is the premium spent, but the idea is playing for a large move to the upside in the back half of the year while rolling the short side of the calendar out and hopefully up, leaving us with cheap upside.