Lululemon athletica (NASDAQ:LULU) shares have lost more than half their valuation in the last year, including 16% on Thursday June 12, 2014. The company's earnings have been poor during this time span, yet many investors are now calling it a value play. Which begs the question: should investors buy the bottom or stick with the likes of Under Armour (NYSE:UA) and Nike (NYSE:NKE)?
What's wrong with Lululemon?
Lululemon has numerous issues right now, all of which resulted in disappointing comparable-store sales that increased just 1% in the first quarter. This follows a fourth quarter when comparable sales actually decreased 2%.
Over the last year, investors have watched as Lululemon has struggled to drive consumers into existing stores. Obviously the fiasco with its see-through yoga pants hasn't helped, but there is also a belief that the company is flirting with peak market penetration.
As a result, it's expanding internationally. But investors have real doubts due to the U.S. and Canada being the largest regions for yoga and knowledge surrounding the practice being relatively unknown in other parts of the world. In order to hedge this uncertainty of global success, Lululemon has invested heavily into growing its e-commerce channels.
The problem is that much of Lululemon's past success revolved around its store experience and the touch-and-see aspect of its product. Without this experience questions arise as to whether consumers will be willing to pay a premium for yoga pants.
If it gets too cheap
Given Lululemon's seemingly endless problems during the last 12 months, some have actually speculated that its falling share price is certain to attract the interest of Under Armour or Nike. Both Under Armour and Nike continue to sport impressive same-store sales figures, and much of the reason for each is a growing women's brand.
While Nike has been hard at work boosting its presence for women during the last decade, Under Armour crossed the $500 million in revenue threshold last year in the women's category and expects the division to eventually top $2 billion in sales. Hence, there is some logic to the Lululemon takeover chatter.
But like all bullish assumptions surrounding Lululemon, this too comes with a fair amount of skepticism. Specifically, the company has weak patent protection on many of its products, which has been widely discussed. Therefore, it makes little sense for Nike or Under Armour to pay $6 billion-plus for fabric and a product that either one could easily create with even better distribution channels.
What should you do?
At 20 times earnings, Lululemon might appear cheap, but the problem revolves around the uncertainty surrounding this company. Thus, Nike and Under Armour, at 25 and 70 times trailing earnings, respectively, might be more expensive but do have the growth consistency and rising margins to make investors feel comfortable in initiating a long-term position.
In regard to margins, Under Armour has spent aggressively in the last few years on international and product expansion. Therefore, its operating margin is only 11%, less than half that of Lululemon. Therefore, as Lululemon expands, margins will most likely continue to deteriorate while Under Armour still has great upside in the profits it can eventually create.
With all things considered, an investment in Lululemon makes little sense for both retail investors and larger sports-apparel companies. There simply isn't a lot for the company to offer.
But, Under Armour and Nike have a more diversified presence and continue to grow explosively. As a result, investors will likely find far better long-term value in either two companies, especially Under Armour, a company expected to grow 25% and 22% over the next two years, respectively.
Brian Nichols owns shares of Under Armour. The Motley Fool recommends Lululemon Athletica, Nike, and Under Armour. The Motley Fool owns shares of Nike and Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.