There's Room for More Than One Winner in Apparel

Lululemon (NASDAQ: LULU  ) is a premier brand that is part of a fast-growing segment within the apparel market. Industry data points out that the global sportswear market is worth over $250 billion and it is growing at a high-single-digit compounded growth rate.

The apparel market space has grown increasingly competitive, and many names in it have proven attractive for investors.

Leave the past in the past, look toward the future
Now that 2013's negative publicity is in the past, Lululemon has a fresh start to 2014 and beyond in which it can offer investors exposure to a specialty retailer. The company has likely reached saturation in Canada (where it traces its roots), but it has the potential for another 100 to 150 stores in the U.S. over the next few years, according to analysts at Oppenheimer.

Lululemon has extremely small exposure to the international market, which represents less than 10% of its sales. Lululemon uses a unique strategy in which it builds showrooms to help raise brand awareness before opening stores in those locations a few years later. The company currently operates 15 showrooms in countries where it does not have stores, such as Germany, Netherlands, Hong Kong and Singapore.

Lululemon is also set to open a 3,100-square foot store in London's Covent Garden, and the company commented that it does "plan to open more stores throughout the UK."

Competitive pressures not to be ignored
After essentially creating the market for its products several years ago, Lululemon can be seen as a victim of its own success. The popularity of the Lululemon brand has sparked other retailers to offer products with similar features at both similar and lower pricing points.

The Gap (NYSE: GPS  ) is an ideal example of a company that offers its customers apparel at both the high- and low-end price points.  Its Athleta brand sells yoga pants for as much as $98 and its Old Navy brand sells $20 yoga pants.

Athleta has been expanding its store base recently to face Lululemon head-on and it could be considered Lululemon's greatest threat because it has much more financial resources and an already-existing global reach. The Gap plans to open 30 Athleta stores to bring its total count to close to 100 by the end of the year.

According to Jaime Katz, an analyst at Morningstar, "the folks at Gap have built brands from the beginning, and so if anyone knows how to execute and do this properly and take this from 20 or 50 to 300 stores or 1,000 stores globally, it's the people at Gap. They have a wealth of talent to draw on and they have the relationships to get things done."

Underappreciated brand deserves closer attention
Under Armour (NYSE: UA  ) continues to leverage its association with basketball, soccer, and now everyday casual-wear and apparel while differentiating its products through technology.

According to research firm MarketsandMarkets, the wearable electronics market will more than triple to $8 billion by 2018.

Under Armour is at the forefront of combining wearable technology and other apps with its apparel, a market which Lululemon seems to be ignoring for now. In 2013, Under Armour completed its first-ever acquisition by purchasing the app maker MapMyFitness for $150 million. According to the company's CEO, Kevin Plank, MapMyFitness is intended to "provide real data for athletes, coaches, trainers or just someone who has a goal of walking 10,000 steps a day." Plank also justified the acquisition and said "It's a long term play in the space. There is no reason we should just sit around and wait for Google to do this." 

Under Armour also issued a bold promise to investors as it plans to double its revenue by 2016 to $4 billion by turning its very iconic American brand into a global one.

According to analysts at Morgan Stanley, Under Armour has the potential for 20%-plus revenue growth over the next several years because of its new product innovation, store expansions, and international growth.

My Foolish conclusion
It is difficult to present a bullish thesis for Lululemon given the negative press the company received in 2013. Investors should instead focus on the company's solid balance sheet, which includes around $4 per share in cash and its ability to generate cash flow to fund capital expenditures.

The Gap has high hopes that Athleta could become the "fourth iconic brand" within its portfolio "sooner rather than later." Investors can take comfort in knowing that The Gap is prepared to back its Athleta brand with tremendous resources to grow the business.

Meanwhile, Under Armour recently approved a 2:1 stock split and the company is also well positioned outside of apparel with its footwear products.

Diversification is important when it comes to this very tricky sector. Investors should consider buying Lululemon in addition to either the Gap or Under Armour (or buy all three) to gain exposure to three excellent brands.

What does the future hold for retailers?
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  • Report this Comment On March 25, 2014, at 1:26 PM, HubbaBuba wrote:

    Yes, there's always room for more. But there's not a credible way to run a DCF with a FORWARD P/E above - much less near TWICE (!), the growth rate (35%). I suppose if you want to mystically assume the "law of large numbers" (in the billions of $) tends to go the other way and revenue and earnings magically increase faster as the company grows more into the billions of dollars. (I believe history and reality will dictate the contrary.)

    A "good company" is not worth just any price. Nor this one. As I've said before - Myself, I think UA (perhaps the whole niche in various degrees) benefited from a bit of a one-off - the strong trend sporting goods clothing/shoes switch to the vibrant neon colors. I believe (actually noted coincidentally when looking myself) last Q UA seemed to have a disproportionately large amount of it's clothing in neon colors (e.g. lime green). Okay, most adopters who care to have by now largely bought into the fad. (Let's face it - much in the sector is "fad to fad" perceived "must haves".)

    Anyway, by now everyone is just as neon draped across their lineups as UA. (Although I think Nike was well positioned in shoes - just not as much clothing.)

    Anyway, that momentum of sales boost, like the share momentum and the color of the neon clothes, will all be fading.

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