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High-Growth Investments Take a Bite out of Under Armour’s Profits

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Analyzing Under Armour’s profitability drivers in 2Q15

Under Armour’s (UA) overall profitability declined in 2Q15. Operating profit margin came in at 4.1% of sales, compared to 5.7% in 2Q14. Operating profit declined by 8% year-over-year to ~$32 million in 2Q15. Profitability was affected on both the production side and the selling, general, and administrative (or SG&A) side.

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Gross margins

Under Armour’s gross margins contracted by 0.8% in 2Q15, coming in at 48.4%. Profitability declined due to higher airfreight costs incurred in the quarter and foreign exchange headwinds. Airfreight adversely affected the company’s gross margin by ~0.5%, while the higher US dollar lowered its gross margin by ~0.6%. The adverse impact was partially offset by higher profitability from Under Armour’s Factory House stores and the revenue from its Connected Fitness purchases, which raised its gross margin by ~0.2%.[1. According to comments by Under Armour CFO and COO, Brad Dickerson]

In comparison, peers Nike (NKE), Columbia Sportswear (COLM), and Lululemon Athletica (LULU) have clocked gross margins of 45.9%, 45.8%, and 50.3%, respectively, in their trailing 12 months. The S&P 500 Consumer Discretionary Sector Index (XLY) had an average margin of 33.5%.

The West Coast Ports standoff affected almost all retailers (XRT)(XLY) expecting deliveries on the Western seaboard. The logjam saw many consumer firms airfreighting shipments to stores. In fact, the problem led to an increase in the cost of airfreight overall, as sector demand for the service increased.

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SG&A costs climb

Despite lower marketing costs relative to sales, planned store rollouts in the quarter and higher digital investments saw operating costs rise. Under Armour’s SG&A expenses overall rose to 44.3% of sales in 2Q15 from 43.5% a year earlier.

Cost outlook

Over the medium term, Under Armour’s profitability is likely to benefit from the increasing sales contribution from its direct-to-consumer (or DTC) channels and connected fitness to its total revenue. That’s likely to be tempered by higher digital investments, marketing, and occupancy costs. But as a growth company, Under Armour’s more likely to look at a higher quantum of profit rather than profitability—at least until its high-growth period abates.

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