S&P Global Ratings revised its outlook on the debt ratings of Under Armour to stable from positive as the company’s operating performance has weakened, leading S&P to expect soft demand and margin pressure to last longer than previously anticipated.
S&P at the same time affirmed all of its ratings, including our ‘BB’ issuer credit rating.
The stable outlook reflects S&P’s expectation for the company’s sales and profitability to continue to improve after a weak fiscal 2023 and for long-term leverage of 2x-3x.
S&P said in its analysis, “Under Armour reported gross margin declines of 650 basis points for the third quarter ended December 2022 driven by higher promotions, mix impacts from higher footwear sales, and foreign exchange. Higher promotions are a result of industrywide dynamics as apparel and footwear companies had excess inventory entering the back half of the calendar year 2022. As of December 2022, the company had 50 percent more inventory than it did in December 2021, partially due to industrywide supply chain constraints in the prior year, but also because the company did not clear as much excess inventory as it expected. Despite elevated promotions during the holiday season, consumers pulled back on discretionary spending on activewear despite its higher demand during the pandemic.
“We expect a mild recession in 2023 and interest rates rising to 5 percent will pressure consumers’ discretionary income. This will likely lead to higher inventory levels at Under Armour’s wholesale partners and longer promotional periods for apparel and footwear companies. We also expect the return to travel and social activities to continue, which will siphon off more consumer spending from discretionary categories. Therefore, our base case assumes a low-single-digit percent expansion in the company’s overall revenue, mostly due to increased sales in international markets.
“We forecast Under Armour’s EBITDA margin will contract in fiscal year 2023 due to higher promotions and elevated costs for ocean and air freight and labor. We estimate the company’s EBITDA margin will fall to about 10 percent, which is lower than its larger direct competitors’ and close to the level it faced when experiencing brand degradation issues over five years ago. At that time, the company’s EBITDA margins declined to a high-single-digit percent from the mid-teens percent area, while its revenue declined due to lost market share. Longer term, we believe the company’s brand elevation strategy will lead to less volatility. However, the macroeconomic uncertainty will make it difficult to improve the brand over the next 12 months.
“In our view, the Under Armour brand is better positioned than it was several years ago, but the macroeconomic uncertainties delay further progress.
“We believe the weak macroenvironment will challenge Under Armour’s return to its former growth levels in North America. However, we note the composition of the company’s business continues to evolve–including significantly reduced sales to the off-price channel, less promotional and discount activities during normalized macroeconomic times and a revamped brand marketing strategy–and that it has had success with recent product launches. Additionally, Under Armour has refocused and is using highly targeted digital advertising to attract its target performance-athlete demographic, which now includes younger athletes. Maintaining its market share will depend on how well management’s merchandising and pricing strategies resonate with customers, as well as its ability to form successful endorsement relationships with high-profile athletes, such as Stephen Curry, Justin Jefferson and Jordan Spieth. Lastly, we believe the ongoing trend toward casualization, along with the elevated consumer focus on health and wellness, will continue to support the demand for Under Armour’s products over the long term.
“We expect the company to begin to use its abnormally high cash balance primarily toward share repurchases.
“Under Armour’s cash balance decreased to $849.5 million from $1.7 billion in December 2021. The large decrease is mainly attributed to a $408 million use of cash for inventories, $187 million in capital expenditures (CAPEX) and $425 million for share repurchases (inclusive of the company’s transitional quarter). To date, the company has repurchased $425 million (including its fiscal year transition quarter) under its $500 million authorization that was approved in February 2022.
“Additionally, the company entered a $75 million accelerated share repurchase of its Class C common stock in the third quarter. The use of cash combined with EBITDA decline has increased leverage to 1.4x from 0x, which is still low but mostly attributable to a temporarily high cash balance that exceeds its funded debt. Under Armour’s management is targeting leverage in line with that of its investment-grade peers, though it has not issued a formal financial leverage target. We estimate Under Armour’s fiscal 2023 leverage will be about 1.5x (net 95 percent of cash). However, we do not expect it to maintain its leverage at this level over the near- to medium-term because the company needs to make CAPEX investments that it has delayed due to macroeconomic uncertainties. Under Armour may also use some of its cash to undertake tuck-in innovation- or expertise-based acquisitions, though we do not expect such activities to increase its reported debt balances given its current cash balance and the cost of new debt.
“The stable outlook reflects that the company will improve profitability over the next 12 months from a weak fiscal 2023 and our expectation of leverage of 2x-3x over the long term.”
