The Long and The Short of It
By Michael Hlinka
There’s an investing strategy known as a “paired trade”. This happens when an investor finds two companies with relatively similar profiles; they typically compete in the same industry with similar strategies and are approximately as risky (or volatile as measured by beta). One stock is purchased with a similar dollar amount shorted, in the belief that if markets go up, the long will appreciate more than the short, and if markets go down, the short will sell off more than the long.
This month I’ve got a paired trade: I recommend going long Under Armour Inc Class A (NYSE:UAA) $8.07 and shorting Nike Inc (NYSE:NKE) at $110.39.
About eight years ago, Under Armour was a Wall Street darling. The company was impressively growing its revenues and seemed poised to present a real challenge to the dominance of its bigger and more established rival, Nike. Unfortunately, they hit a bump in the road with sales laggin, and even falling short, before picking up slightly last year. UAA reports its year-end as of March 31st, and its year-over-year growth was 3.1%, a number that can’t excite anyone – especially for a growing company.
Nike’s year-end is May 31st and its revenue grew by 9.7% during the past fiscal year. Over the years NKE has been a consistent grower: its annual compounded growth rate during the past decade is just above 7%. That being said: growth has started to abate which is understandable. The bigger a company gets, the more difficult it is to grow exponentially. On the flip side, NKE enjoys better economies of scale, particularly when it caomes to expenses, including the sales and G&A (general and administrative) that UAA does not… or at least not yet.
There is a significant difference in size between these two companies: UAA’s revenues stand at just under $6 billion, while NKE’s are north of $50 billion.
Then why UAA instead of NKE?
UA is trading at a price/sales ratio of 0.57 while NKE’s is 3.3. The discrepancy seems much too wide, and it makes UAA an attractive take-over target, or merger partner. I confess that I don’t know what entity might ask for a walk “down the aisle”, but UAA is an attractive mate.
What could make even more sense is for a private equity firm to scoop it up. UAA is carrying very little debt and a ton of cash.
I see many different potential catalysts for a surge in UAA’s share price, potentially to $11 (which translates to a 50% return), whereas I see NKE being dead money for at least a few years to come. In addition, a selloff of up to 20% is not out of the question if top-line results disappoint.
There’s one more general comment I’d like to make, and it’s something I’m noticing with a myriad of other well-known brands and industry leaders. It strikes me that in the wake of COVID, many investors are embracing iconic brands first, and considering valuations second. This phenomenon pertains to companies as diverse as the Walt Disney Co (NYSE:DIS) and Starbucks Corp (NASDAQ:SBUX) and Amazon.com, Inc. (NASDAQ:AMZN), and I put NKE in that camp as well.
Bottom line: To play this trade, we want to long UAA and short NKE and both positions when they’re up by 20% or down by 20%.
All articles published by PAIP Canada Inc. are for informative purposes only, and do not constitute advice. We recommending consulting by a subject matter expert before making any financial decision(s).