Under Armour (UA +2.80%) (UAA +3.03%) and Lululemon's (LULU +1.41%) paths diverged over the past three years. UA's stock plunged over 40% as it struggled with soft demand in North America and tougher competition from Nike (NKE +1.90%) and Adidas (ADDYY +3.83%). Lululemon's stock surged nearly 200% as it retained its position as the "best in breed" leader of the booming athleisure market.
Therefore investors are likely wondering why UA isn't expanding into the athleisure market to diversify its business away from traditional footwear and athletic apparel. However, UA CEO Kevin Plank dismissed that notion in a recent CNBC interview, stating that the company planned to stick with "performance" products instead of entering the athleisure market. But does that strategy make sense, considering how crowded the "performance" market is and how fast the athleisure market is growing?
Image source: Under Armour.
Performance vs. athleisure
The "performance" market which Plank highlights generally consists of two segments: activewear, which prioritizes performance (like minimizing muscle strain or wind resistance) over looks, and athletic footwear.
The global activewear market could grow at a compound annual growth rate (CAGR) of 6.8% between 2018 and 2024, according to ReportBuyer. The global athletic footwear market could grow at a CAGR of 7.2% between 2019 and 2024, according to Mordor Intelligence. The global athleisure market is expected to grow at a CAGR of nearly 7% between 2019 and 2023, according to Research and Markets.
Those growth rates look comparable, but the markets are fragmented differently. Nike and Adidas dominate the athletic footwear and athletic apparel markets, while UA trails in a distant third across most markets. The performance market also relies heavily on celebrity endorsements -- and Nike and Adidas have much deeper pockets than UA.
Lululemon enjoys a first-mover's advantage in the high-end yoga apparel and athleisure apparel market. It generated double-digit comps growth over the past year by blurring the lines between fast fashion and activewear, and its gross and operating margins expanded annually last quarter, which highlights its pricing power and indicates that customers are fiercely loyal to its brand. It reinforces that lead with free yoga classes and community events. Therefore, it would be tough for UA to establish a foothold in that market and generate growth comparable to that of Lululemon.
Image source: Lululemon.
Understanding UA's problems
Under Armour has been struggling with several headwinds in recent quarters. Sales in North America, its top market, fell annually for four straight quarters as Nike and Adidas opened more brick-and-mortar stores, launched fresh ad campaigns, and introduced new products. UA's international sales growth is also decelerating.
UA's direct-to-consumer (DTC) sales only rose 2% last quarter, which was anemic compared to the double-digit DTC growth at Nike, Adidas, and Lululemon in their latest quarters. Its apparel sales, which rose 5% in 2018, also dipped 1% last quarter.
UA remains a weak underdog in footwear and apparel, but it's cutting operating expenses to improve its margins. Unfortunately, conservative spending also throttles its ability to develop new products, open new stores, or launch aggressive marketing campaigns against Nike, Adidas, and Lululemon.
Big promises and mixed messages
Last December, UA launched a five-year turnaround plan with six core tenets: creating "innovative athletic performance" products; leveraging analytics and its fitness apps to strengthen its brand; improving its digital engagement rates; investing in the growth of its international, DTC, footwear, and women's businesses; preventing the dilution of its brand in wholesale channels; and delivering "balanced" growth by controlling costs.
It believes that those initiatives will enable it to return to a low double-digit growth rate by 2023 as it grows its EPS by a CAGR of about 40%. That sounds optimistic, but we should recall that UA also once promised to generate $7.5 billion in revenue by 2018 -- but ended up hitting just $5.2 billion.
We should also recall that Kevin Plank repeatedly promoted UA as a "tech" brand instead of a footwear and apparel brand over the past decade. However, the tepid demand for UA's products indicates that it's just another apparel brand -- and a weak one at that.
That's why UA doesn't want to compete with Lululemon
In my opinion, UA's reluctance to enter the athleisure market doesn't really have anything to do with focusing on "performance".
Instead, it's likely because UA knows that it can't beat Lululemon, which is already expanding beyond its core market of female shoppers into the menswear and footwear markets. UA can't compete against Lululemon's first-mover's advantage, its pricing power, its brand loyalty, or the strength of its DTC ecosystem, which generated 31% constant currency sales growth last quarter and accounted for nearly a quarter of its top line.
Therefore, Plank is falling back on his old arguments about UA being a performance or tech-oriented brand, which sounds sexy but ultimately means nothing. Simply put, UA just doesn't want to challenge another market leader when it can't even keep pace with Nike and Adidas in its core markets.
