Wicking, Tennis Shoes & Speed Bumps

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Under Armour (UAA)

Subscribers may remember our explorations and discussions inspired by Charles Carlson about the avoidance of being “stubborn” in investing. (See Rules of Engagement , December 2008) His Rule #8 was “Have the Courage to Act on Your Conviction, BUT, Do Not Confuse Conviction with Stubbornness.” We might also remind ourselves about the conviction displayed by David Gardner and his exemplary performance for the Motley Fool Stock Advisor newsletter. (First Break The Rules , April 2016) His mettle was definitely tested with Amazon, Netflix and others while remaining steadfast on the path to exceptional returns. Which brings us to one of the Motley Fool Faves … and our May 2016 selection of Under Armour.

Under Armour was selected for this feature nearly a year ago. The stock price has dropped approximately 42% since then — while the general market has been “en fuego.”

Apparel retail is never easy. Entering the competitive fray with the likes of Nike and Adidas to deliver shoes could definitely be characterized as kicking sand on an 800-lb gorilla or two.

On top of that, a confusing whirlwind of ticker changes and voting rights “innovation” lead to a confusing and uncertain impression that scatters the institutional investors like screaming “Fire!” in a movie theater.

The ultimate result is the price swoon shown in the accompanying figure.

Growth, Profitability, Valuation

The Manifest Investing sales growth forecast for UAA is 11.2%. Value Line has a 3-5 year sales growth forecast of 24%. Morningstar sees growth in the 11-12% for 2017, a “sharp deceleration” from 22% in 2016. S&P still sees 18% earnings growth going forward.

We’re using 6.7% for the projected net margin. The average net margin has been 6.3% for the period 2009-2016. Value Line has a 3-5 year projected net margin of 12.7%. Under Armour is clearly in the throes of a life cycle profitability speed bump.

The median P/E for the period 2009-2017 is 43.2×. Value Line has a projected average P/E of 35.0×. We’re using approximately 30x for the projected average P/E.

At the time of selection (2/7/2017), the stock price is $20.47, the projected annual return is 11-12%. The quality RANKING is 95 (Excellent) and the financial strength rating is 91 (A+).

Points of View

On 1/31/2017, Value Line reduced expectations for revenue growth and EPS for 2017. The company also announced the departure of the CFO — another log on the uncertainty fire when it comes to the institutions. Value Line continues to advise “all but the most aggressive investors to look elsewhere … for a company already facing multiple headwinds.”

We mentioned David Gardner and his loyalty to some of his more turbulent selections over the years. As we noted in the article, many of his best performers encountered extreme speed bumps. And it was his brother, Tom Gardner, who selected Under Armour on 9/20/2013 at $19.47.

Our experience has been that speed bumps are inevitable during the life of all companies, even the bluest chips. One often occurs after the expiration of the IPO restricted period. A second often occurs after emerging into consistent positive profitability and I think we’re seeing this here. We’ll take a look at a 45-year analysis of Nike to illustrate and make mettle testing manifest.

A Few Moments With Life Cycles, Courtesy of Nike (NKE)

I’m not sure why I hadn’t done this yet. We did take a 20-year look at CSX (CSX) a while ago to examine long cycles. But this is for a different reason. I remember a 30-year Stock Selection Guide article that was contributed to the Better Investing BITS newsletter by Diane Graese many years ago. In the article, Diane shared a very long term perspective on Dana Corporation, complete with all of its cyclical warts and wrinkles. It’s time to go back.

You can’t do this (meaningfully and with as much relevance) for companies that have a lot of M&A activity in their history.

But in this case, Nike is relatively clean in this regard. Although it has evolved, Nike has been basically the same company with a fairly steady capital structure and product portfolio for many years.

Nike (NKE): Business Model Analysis (1984-2020). Sales growth has been fairly steady for an apparel retailer over the years, checking in at low double digits since inception. The sales growth trend and forecast for 2004-2018 is closer to 8%. The emergent EPS point is clearly shown for the company in the mid-1980s. Stock price? Stock price follows earnings. Rinse. Repeat. Nike shareholders are smiling and wouldn’t be surprised to be owned by Berkshire Hathaway some time soon with a chart like this.

Nike (NKE): Profitability as measured by Net Margin (1984-2020). This is a powerful long term trend. The moment that we notice — that I believe has context with respect to Under Armour — is the 1998 downdraft in profitability. Global recessionary pressures at the time, in combination with diminishing returns from Peak Air Jordan, came together in a perfect storm that resulted in some optimization, investment in infrastructure and product portfolio shuffling. The result was a “speed bump” in earnings that impacted stock price and generated something of a stock price plateau for a few years. But persistent year-after-year gains in profitability and earnings wears down the most steadfast rhino over time. This chart, as part of our Management Report Card for any company, is exemplary when it comes to Nike.

Nike (NKE): Valuation (1984-2020). The P/E ratio languished during the early years (1984-1988) until the EPS stabilized “north” of 0%. Nike never saw the types of P/E ratios that a company like Under Armour has exhibited — but a P/E ratio in the high teens is fairly easily defended. The P/E ratio trend will often track on a trajectory similar to the profitability and that seems to be the case with Nike.

Update on Under Armour

Under Armour (UAA): Update. Growth expectations have been slashed for 2017 and perhaps, 2018. The impact on 2017, 2018 and the 3-5 year forecast has been reflected here.

Bottom line? I really do believe that Under Armour is going through the same type of speed bump experienced by Nike at the 10-15 year mark. Kevin Plank has aggressively grown the company, the products are outstanding and the customers are loyal.

Under the reduced expectations discussed by Value Line (1/31/2017) the return forecast is now low double digits. But with the average stock at 5-6% and the prospect (long term) of beating the sales and profitability expectations — even while the average P/E ratio moderates — this could be rewarding for the most adventuresome out there with appropriate time horizons.

Novo Nordisk (NVO)

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Solomon Select (October 2016)

Novo Nordisk (NVO)

This month we take a look at another “flavor” of repeat selections. Guest damsel Kim Butcher presented this world class leader in insulin and diabetes care during the August and September Round Table webcasts. The audience was polled and sanctioned the nomination both times.

As detailed in recent Barron’s coverage, Denmark’s Novo Nordisk (NVO), the global leader in diabetes medications, will get a new CEO in January, when company insider Lars Fruergaard Jørgensen takes the reins from his long-serving predecessor. But don’t expect the company’s strategy to change, even though increased competition and turmoil in the U.S. health-care market lately have pressured results.

NVO intends to stay the course, building on its No. 1 status in diabetes management, and expanding its drug pipeline into other lucrative areas, such as medications to fight obesity, hormone regulation and treatment of hemophilia. With a portfolio of new and more efficacious diabetes drugs, and other promising treatments in the wings, the company is likely to win back investors.

Novo Nordisk (NVO): Business Model Analysis. 9-10% top line growth has been the trend for NVO in the face of economic pressures in Europe and the long term market drivers (demographics and obesity macro trends) suggest continuing growth. Profitability has been steadily improving but will likely plateau under competitive pressures and P/E ratios in the realm of 20x seem reasonable going forward.

Growth, Profitability, Valuation

The Manifest Investing sales growth forecast for NVO is 9.2%. Value Line has a 3-5 year sales growth forecast of 10% and Morningstar “dissents” a little with 5% revenue growth expectation through 2020. The company has scaled back top line growth projections for 2016 to 5-7% and the analyst consensus expects a continuation in 2017. Novo Nordisk “should return to double-digit growth when new products reach critical mass,” says ABG Sundal Collier analyst Andrew Carlsen. But that might not happen before the end of 2018. By then, sales of new products could offset the effects of U.S. pricing pressure.

We’re using 31.0% for the projected net margin. The average net margin has been 28.2% for the period 2010-2015. Value Line has a 3-5 year projected net margin of 34.0%. The trend as shown in the accompanying profitability graphic is strong and in the right direction. Morningstar acknowledges pressures on margins but stipulates that manufacturing efficiencies and product mix will alleviate some of this.

The median P/E for the period 2008-2015 is 20.3×. We’re using 21x for the projected average P/E.

At the time of selection (10/4/2016), the stock price is $40.63, the projected annual return is 15-16%. The quality RANKING is 99 (Excellent, Top Shelf) and the financial strength rating is 94 (A+).

Points of View

The Value Line low total return forecast for NVO is approximately 12%. Morningstar has NVO with a fair value of $51 for a price-to-fair value ratio of 82%.

Last week, the company announced it would cut about 1,000 jobs from its 42,300-strong workforce to reduce costs. The move underscores Novo Nordisk’s struggle to maintain strong growth amid the competition in the insulin market, which accounts for more than half its sales. The company has a strong track record when it comes to return on research invested, comparing favorably versus Sanofi and other major pharma players. That said, the departure of the CEO and the apparent intentions to expand efforts in new insulin technologies and other frontiers could possibly mark a directional shift for the company. Value Line continues to look for expansion of the diabetes business … issue took a hit following loss of a contract with Express Scripts and lowered guidance … creating a potentially favorable entry point for patient investors.

Skyworks Solutions (SWKS)


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Ken Kavula stole the show during our recent Round Table with his nomination of SWKS, a specialty semiconductor company.

The audience vote at the August Round Table was a landslide. The kind of landslide that takes no prisoners. Despite the presentation of a couple of worthy and formidable nominees, Ken Kavula stole the show with his nomination of Skywork Solutions (SWKS) … a specialty semiconductor company that has beaten a world class path into the Internet of Things.

Our monthly Round Table generally takes place on a Tuesday evening near the end of every month. We sometimes switch the session to a Saturday morning for some variety or to avoid Hugh’s robust travel schedule. The webcasts are FREE and you’re welcome to invite friends, family or any should-be long-term investor that you know. A handful of stocks are presented complete with analysis and a nudge toward favorite resources for further study, reinforcement and verification. We archive almost all of the sessions on the MANIFEST Forum. You can also use YouTube to track down recorded sessions and/or to share them with your fellow long-term investors. Here is a link to August Round Table starting at the SWKS segment.

Skyworks Solutions (SWKS): Business Model Analysis. Earnings “went positive” and stayed positive fpr Skyworks back in 2005. They’ve not looked back, continuing to develop and market scores of analog and mixed signal semiconductors worldwide. Growth appears to be capable of sustaining double digits and profitability has steadily strengthened. Depending on your outlook for these key characteristics, the return forecast is 10-15%.

Growth, Profitability, Valuation

The growth rate forecast (based on 2014-2019) is 14.7%. Value Line is using 17.5% for their 3-5 year forecast. Morningstar expects 8% growth over the next five years. Based on the visual analysis of the business model, 12-15% seems feasible.

2014 delivered a net margin of 20.0%. Value Line has an average net margin forecast of 26.8% for 2015, 2016 and 2019. This is probably the most influential assumption about the company and analysis. Since emerging and sustaining profitability less than ten years ago, net margin has advanced and is probably headed for a plateau. Based on industry and inherent company characteristics, what level of profitability do you believe is achievable and sustainable? Your answer will dictate whether this stock is in a “buy zone.”

Value Line is using 20x for the 3-5 year projection. The analyst consensus is a little more optimistic, checking in at 25×. At $83, the return forecast is approximately 15%. Phone home.

Apple (AAPL)

With products that are pervasive and ubiquitous and the #1 ranking in our MANIFEST 40 most widely-followed stocks, it’s time for Apple to join the Solomon Select tracking portfolio. We’ve waited patiently for the stock price to drop from $705 to $400 and the fundamentals are still very much intact. Our anecdotal analysis of price disruptions on the heels of relative strength breakdowns and breaches in momentum suggests that the worst may be over.

On a CNBC appearance yesterday, Jeff Gundlach confessed that DoubleLine is now “long” Apple after rocking the investing world with his expectation of $300-something while it was soaring in the upper $600s 9-10 months ago.

Growth, Profitability, Valuation

The Manifest Investing sales growth forecast for AAPL is 14.2%.

We’re using 23.2% for the projected net margin. Value Line has a 3-5 year projected net margin of 26.6%.

The median P/E for the period 2008-2017 is 15.2×. We’re using 14x for the projected average P/E.

At the time of selection (5/31/2013), the stock price is $449.73, the projected annual return is 20-21%. The quality RANKING is 98 (Excellent) and the financial strength rating is 90 (A+).

The company has historically held no long-term debt but recently committed to low-interest rate bonds as an offset vehicle (tax optimization) to ‘proxy’ a repatriation of offshore cash reserves to fund buybacks and dividends for shareholders.

Points of View

Morningstar has AAPL with a fair value of $600 for a price-to-fair value ratio of 74% and rates the company a “buy.” S&P rates the company a “strong buy” at fair value of $473.20, or a P/FV of 94%.