Sports Marketing: High Valuations Keeping Investors Away

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Submitted by Morgan Smith as part of our contributors program.

Growing demand for sports apparel and sports marketing is a phenomenon unto itself. It’s not an emerging market story since Nike (NKE) has posted double-digit revenue growth in developed markets, even as China slows. It is not about demographics since populations are aging in regions with sales growth. Instead, it’s about hope and the belief that anyone, even you, can overcome adversity or become a champion.

This faith is bigger than individual athletes. Indeed, the market is robust to scandal as media attention and endorsement deals move from Tiger Woods and Lance Armstrong to up-and-coming sports heroes. For example, as Nike dropped Mr. Armstrong from its celebrity portfolio it added Real Madrid’s Pepe from Soccer and Russell Westbrook from the NBA.

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The sports apparel industry is interesting to investors because industry margins can be very high, making successful brands very valuable. Once a brand is by very costly marketing efforts the product that is produced is low-cost. What’s more, trademarks and copyrights protect industry players from direct price competition.

Hero Paydays

There are many ways to participate in the market for sports apparel. It can be argued that it is better to be an athlete than the shareholder of a sports apparel firm. Adidas (ADDYY), the only reasonably-valued sports apparel stock listed below, contracted tennis champion Andy Murray to a five-year endorsement deal worth $4-5 million per year. Mr. Murray recently won the U.S. Open, which is a boon for Murray and Adidas. Note that Mr. Murray signed this lucrative deal three years before he was a champion. Equity investors would have needed a $70 million investment in Adidas so that the firm’s 5.7% earnings yield could match Mr. Murray’s $4-5 million annual return to his human capital.

Since sports fame is unlikely for most investors, let’s consider the soccer franchise Manchester United (MANU) stock as an investment. Unfortunately, at a price of nearly $12 this stock is wildly overvalued. Manchester United shares are trading at an enormous 6,235 price-to-earnings ratio. Investors can buy more revenues per dollar from the S&P500 since this index has a price-to-sales ratio of 1.29 while this stock has a much higher 3.77 ratio.

Another promising niche in this industry is sports and fitness modeling and stock photography. Suppliers of stock photographs can sell directly to the buyers or it can also deal with a number of large modeling agencies that can manage and broker their photographs. These not images of top-tier athletes or celebrity, but images of anonymous models often the backbone of marketing campaigns.

W Athletic is an example of a modeling agency that represents models who are fit and appropriate for sports accessories and active lifestyle marketing. The London-based company was founded in 2007 as a multi-disciplined modeling agency that brings in talented individuals from many different backgrounds, including actors, dancers, gymnasts and performers. Its contracted models are hand-picked from between 500 and 750 monthly applicants. W Athletic’s models are featured in ad campaigns on a global scale. The company has a long list of notable clients, including Gillette, Nike, Adidas, Reebok, Puma, Guinness, ASICS, Zest, Men’s Fitness, Activia, Nokia, Sky, Nivea, Microsoft and even McDonald’s.

Flagrant Valuation Fouls

Unfortunately, many sports apparel companies are trading at very high valuations. Investors should exercise discipline and wait for lower valuations or find other ways to invest in the sports apparel ecosystem.

Lululemon Athletica (LULU) is a sports apparel stock that has benefited from the rising popularity of yoga. This stock trades near $76, a price level is too much of a stretch, even for a yoga master. Investors can buy more revenues per dollar from the S&P 500 since this index has a price-to-sales ratio of 1.29 while this stock has a much higher 7.2 ratio. LULU shares are trading at a lofty 50.7 price-to-earnings ratio, a price multiple which is more than three times the PE ratio of the S&P 500.

Under Armour (UA) stock is too expensive at a lofty price of roughly $59. Investors can buy more revenues per dollar from the S&P500 since this index has a price-to-sales ratio of 1.29 while this stock has a much higher 3.57 ratio. UA shares are trading at an indefensibibly high 59.04 price-to-earnings ratio.

V.F. Corporation (VFC) stock is better than Under Armour, but still too expensive at a price of roughly $169 per share. The firm’s 1.79 price-to-sales ratio is closer to today’s prevailing market multiples. VFC shares currently trade at a high 20.3 price-to-earnings ratio, a higher value than the 14.1 average of the S&P 500 index. The only upshot for investors is the stock’s 1.71% dividend yield. Future dividend payments are likely because the company pays out 0.33 of earnings as dividends, so earnings could drop considerably before dividends must be cut.

PVH (PVH) stock is also somewhat richly valued at a price of roughly $98, a price level which seems impossible to justify. Though the firm’s 1.15 price-to-sales ratio a bit lower than today’s prevailing market multiples, it’s price-to-earnings ratio is high at 21.1.

Nike (NKE) stock is in the same boat since it is a bit richly valued at a price of roughly $98 per share. The firm’s 1.77 price-to-sales ratio is a touch higher than today’s prevailing market multiples. NKE shares currently trade at a high 21.1 price-to-earnings ratio, a higher value than the 14.1 average of the S&P 500 index. The shareholders of this large cap stock have not seen much movement in the stock price over the past year. Fortunatley, they have collected a 1.48% dividend yield of the stock while they wait. Future dividend payments are likely because the company pays out 0.31 of earnings as dividends, so earnings could drop considerably before dividends must be cut.

Adidas AG (ADDYY) shares trade over-the-counter stock near $45 per share at more reasonable valuations. ADDYY shares trade at more reasonable valuations: Adidas stock currently trades at a high 18.72 price-to-earnings ratio and a 1.00 price-to-sales ratio, which is lower than the price-to-sales ratio of the S&P 500. This stock is the only reasonably-priced stock on this list. Potential investors should not buy this stock for short-term gains because this stock is traded over-the-counter at low volumes.

Conclusion

Disciplined investors must wait for sports apparel companies to trade at lower valuations. They should keep an eye on Adidas in particular since its valuation is lower than its peers. Instead, investors should participate in the growth of sports marketing through direct investment in small private ventures.