S&P Global Ratings raised its debt outlook for Under Armour Inc. to Stable From Negative. S&P said Under Armour’s strong first-quarter results “indicate its financial metrics are improving amid the coronavirus pandemic.”
The upgrade also reflects Under Armour’s settling of the investigation by the U.S. Securities and Exchange Commission regarding its pull-forward sales disclosures in 2015-2016 for $9 million.
S&P said its revised forecast indicates revenue growth in the high-teens percentages from its previous high-single-digit expectation and gross margin expansion, resulting in leverage below 2x, well below its downgrade trigger of above three times.
S&P revised our outlook on Under Armour to stable and affirmed all ratings, including its ‘BB’ issuer credit rating.
The stable outlook reflects S&P’s expectation that Under Armour will make substantial progress in its financial metrics over the next 12 months as it rebounds from the pandemic.
S&P said in its analysis, “The outlook revision reflects our expectation that Under Armour will improve credit metrics in 2021 on increased demand in both the North America and international markets, supported by health and wellness trends continuing and consumer mobility improving. Demand is increasing for Under Armour and other apparel peers as economies open amid vaccine rollouts, although it varies by region. We forecast a higher demand recovery in 2021 for Under Armour, with revenue increasing in the high-teens percentage area. Combined with lower restructuring costs and realization of cost savings, that should result in net leverage below 2x in 2021, improving further in 2022. However, the company is holding onto excess liquidity with $1.3 billion cash on the balance sheet, which improves its metrics. We expect it to utilize cash for investments in the business and potentially tuck-in innovation and/or expertise-based acquisitions as volatility from the pandemic subsides. Under Armour ended fiscal 2020 with 2.7x net leverage, as EBITDA in the back half offset losses in the first half.
“We expect Under Armour’s North America segment to expand in the high-teens percentages in 2021, with growth thereafter still uncertain. The company posted first-quarter revenue growth of 35 percent driven by 120 percent growth in Asia-Pacific; 41 percent in Europe, the Middle East, and Africa; and 32 percent in North America. This is the first quarter of meaningful growth since the third quarter of 2019 (the third quarter of 2020 generated flat revenues year over year). New products at higher prices and fewer products sold through discount channels were key drivers to the company’s revenue performance. It is hard to assess sustainable revenue growth levels for the North American segment because there has been an increased degree of consumer spending due to pent-up demand, continued demand for athletic apparel over business attire and the government stimulus. However we note that the composition of the company’s business continues to evolve, including significantly reduced sales to the off-price channel, less promotional and discount activities, it has revamped its brand marketing strategy and has had success with its recent product launches. In addition, we believe inflationary pressures on household products, food, and gasoline could absorb a higher proportion of peoples’ incomes and decrease spending on more discretionary purchases such as apparel and footwear. However, we believe trends toward casualization and consumer focus on health and wellness will support demand for Under Armour.
“We believe the company has refocused and is utilizing highly targeted digital advertising to attract its target performance athlete demographic. Maintaining market share will depend on how well Under Armour’s merchandising and pricing strategies resonate with customers, as well as its ability to form successful endorsement relationships with high-profile athletes such as Tom Brady and Stephen Curry. Management believes it remedied prior issues with products, prices, and inventory management that caused previous declines in its largest North American segment. Under Armour’s brand equity had lost momentum in North America as it refocused its strategy on athletic performance. This reduced market share and revenue. The company generates about 35 percent of its revenue outside of the U.S., providing some diversification to offset its declining North American segment over the last several years. According to the company, the brand’s reputation was not harmed by challenges in North America and continues to be viewed as a premium sportswear brand internationally. We believe international growth and diversification will continue to be a major focus.
“We forecast significant profitability improvement in 2021. Under Armour embarked on various large restructuring initiatives in the past few years to reduce the cost structure, resulting in high volatility in profitability year over year. For example, the company’s EBITDA margins declined from the mid-teens percentages to the high-single-digit area from 2016-2018. Its $600 million 2020 restructuring program, combined with lower fixed-cost absorption on lower volumes because of the COVID-19 pandemic, further depressed adjusted EBITDA margin to the mid-single-digit percentages in 2020. We forecast margins to improve to the high-single-digit percentages in 2021 as those costs do not repeat and the company laps last year’s pandemic-related store closures. Sustaining this expected improvement remains a key rating factor.
“We expect the company’s financial policy to remain conservative amid strong liquidity. We understand that Under Armour’s management is targeting leverage in line with that of investment-grade peers. The company issued $500 million of convertible notes in 2020 that improved its liquidity position as proceeds were used to repay its revolver balance. The notes can be called in December 2022, and we believe the company could seek to buy back some of or all of its debt before then to restore its pre-pandemic debt burden. Under Armour’s $1.3 billion cash balance is more than enough to cover a profitability shortfall if recovery is slower than we forecast. We do not expect the company to utilize its cash balance over the short term for shareholder-friendly activities such as share repurchases or acquisitions. We believe the company, like its apparel and footwear peers, is keeping extra liquidity cushion on the balance sheet until there is less uncertainty around store closures and a return to normalcy.
“We expect free operating cash flow generation (FOCF) above $100 million in 2021, including lower working capital investment, will bolster the company’s liquidity. Under Armour reported $120 million of FOCF in 2020, down from about $360 million in 2019. It decreased capital expenditures (Capex) $50 million. We expect Capex to return to normal near $145 million annually in 2021.
“The stable outlook reflects our expectation that Under Armour will make substantial progress in its financial metrics over the next 12 months as it rebounds from the coronavirus pandemic. The outlook incorporates our expectation for high-teens percentage revenue growth and leverage below 2x.”
Photo courtesy Under Armour
