Under Armour Inc (UA): Either A Great Value Or Overvalued, Which Is It?

I’ve struggled with whether I believe enough in Under Armour Inc (NYSE:UA) to buy the shares or not. I’ve owned shares in the past, but I haven’t been able to bring myself to buy them again since the stock trades for over 30 times earnings. Many times when I looked at Under Armour, I would find myself liking Lululemon Athletica inc. (NASDAQ:LULU) more. However, Under Armour’s current quarter results may have changed that mindset. There is one way of looking at the stock that says it’s overvalued relative to its peers, but in another way it appears to be a bargain.

Under Armour Inc (NYSE:UA)Sports Everything
The revival in sports apparel and shoes has been nothing short of remarkable. When I was much younger, the war between NIKE, Inc. (NYSE:NKE) and Reebok was legendary. In that timeframe, if you wanted to buy shoes, you went to Foot Locker, Inc. (NYSE:FL). Today the landscape has changed, while Footlocker is still around and kicking, new entrants in retail like Dicks Sporting Goods Inc (NYSE:DKS) are changing the game. Dick’s is expanding, and both of these retailers are being helped tremendously by the increased popularity of sports apparel as well as new shoe styles.

This Stock Is Overvalued
A popular case against buying Under Armour stock has been the shares are too expensive. With shares trading at about 34 times projected 2013 earnings, they certainly aren’t cheap. Analysts are calling for EPS growth of 21.37%, which gives the company a PEG ratio of 1.6. Lululemon looks cheaper with a PEG ratio of 1.28, based on a P/E of about 36.7 and expected growth of 28.6%. Investors could also choose to buy Dick’s Sporting Goods as an industry bet, and Dick’s carries a PEG ratio of 1.3, with a P/E of 19 and growth of 14.7% expected.

If you look at expected revenue growth, Lululemon has a leg up on Under Armour as well. The company is expected to report 36.6% revenue growth this year, with Under Armour reporting revenue growth of 21.4%. Even Dick’s is expected to see 13% growth in revenues.

…Or Maybe Not?
If you look at Under Armour compared to Nike, by nearly every measure the stock appears more fairly valued. Nike’s PEG ratio of 2.01 far exceeds Under Armour. In addition, Nike is only expected to see 4.8% revenue growth compared to over 21% at Under Armour. Another factor working in Under Armour’s favor is their strong gross margin.

Under Armour has a much better gross margin than either Nike or the traditional retailer Dick’s. Dick’s carries gross margins of 30.95%, but of course the company operates at the retail level, whereas Under Armour is more of a wholesale operator. The comparison to Nike is more accurate, and Under Armour’s 50.3% gross margin crushes Nike at 42.62%. Only Lululemon has a better gross margin at 55.38%. One major difference is, Lululemon doesn’t produce shoes, which are a lower margin business.

One of the main factors that is causing me to question my valuation of Under Armour is their free cash flow generation. I like to use free cash flow per dollar of sales as a way to compare companies in the same industry. In the last year, Under Armour produced $0.08 of free cash flow per dollar of sales. By comparison, the much larger Nike produced $0.10 of free cash flow, and Lululemon generated $0.05 of free cash flow. Though Under Armour isn’t producing as much free cash flow as Nike, the company’s ability to outperform Lululemon is eye opening. When you consider that Under Armour produced 60% more free cash flow from each dollar of sales versus their closest competitor, this helps explain the high valuation in the stock.

So What Should Investors Buy?
If you don’t want to make a choice, you can benefit from the growth in the industry by purchasing shares of Dick’s. The company pays a 1% yield, and combined with their expected growth of almost 15%, this is a good total industry play. Unfortunately, I just can’t recommend Nike. The shares are far more expensive on a relative basis compared to either Under Armour or Lululemon. The fight between Under Armour and Lululemon is a tougher matchup than it first appears.

Lululemon has the faster growth rate in revenue and earnings, but also carries a slightly higher P/E ratio. Under Armour’s P/E ratio might be enough to scare investors away if they don’t realize how strong the company’s cash flow is. If I had to choose, I might pick Under Armour today. The company’s product lineup is broader based than Lululemon, and their push into women’s apparel should drive positive returns. Investors who want to keep up with this fast growing company should add UA to their Watchlist today.

The article Either A Great Value Or Overvalued, Which Is It? originally appeared on Fool.com and is written by Chad Henage.

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