Investors have been excited by lululemon athletica's (LULU -1.26%) stock for a long time. Since it went public at $18 per share in 2007, the stock has appreciated a staggering 17-fold. That's a roughly 25% average annualized return for just over 13 years.
But today, Peloton Interactive (PTON -0.98%) is the better growth stock. Here's why.
Faster growth
Lululemon's track record of growth is incredibly impressive, having grown revenue almost 219-fold over the last 16 years. That works out to an impressive 40% average annualized growth rate over that period.
But the company's revenue growth slowed to 21% during the fiscal year ending Feb. 2. And at the company's 2019 analyst day, management presented a plan to grow revenue at an annual rate in the low teens for the next five years. That's a meaningful slowdown.
Image source: Peloton Interactive.
Since that analyst day, COVID-19 has made things even worse for Lululemon. In the company's first half of its current fiscal year -- a period that ended Aug. 2 -- revenue fell 7% year over year.
Peloton's track record is shorter, since it only began selling its original bike in 2014, but it's been spectacular. Fiscal 2020, which just ended June 30, was the sixth consecutive year the company has more than doubled its sales, according to John Foley, the company's founder and CEO.
The company hasn't explicitly disclosed sales figures going back that far, but we know the $1.8 billion of sales in fiscal 2020 is a more than eightfold increase over the $219 million of sales achieved in fiscal 2017 three years earlier. That's 103% average annualized growth over the last three years.
Bigger opportunity
While Lululemon's management is not providing guidance due to uncertainty related to COVID-19, Peloton's management is expecting another 96% sales growth in the current fiscal year ending June 30, 2021.
And Peloton has a large addressable market to tackle: There are 183 million gym memberships globally and the company only has 1.1 million Connected Fitness subscribers.
In addition, management estimates there were about eight million bikes and treadmills sold annually for home use just in the U.S. in the year ending March 31, 2019. But even that understates the opportunity, because Peloton is expanding the market: 4 out of 5 Peloton subscribers were not previously in the market for home fitness equipment before buying a Peloton.
The company's first-mover advantage and rapid growth has made it the interactive home fitness company. That's why ESPN aired the Peloton All-Star ride in May, an event that featured professional athletes racing each other on their Peloton bikes from their homes. A much smaller competitor with far fewer users wouldn't have been in a position to get that exposure.
Peloton's significant scale and trajectory gives it the resources and confidence to reinvest in marketing and research and development (R&D). Those investments only further entrench Peloton's competitive position. For example, Peloton spent $89 million on R&D last year. Given $3.58 billion is the midpoint of management's fiscal 2021 revenue guidance, and R&D expense "is expected to be flat as a percent of revenue year over year," which would be 4.9% of revenue, Peloton intends to spend about $175 million on R&D this year.
That's a ton of money being reinvested in developing new products and software features. It's hard for competitors that are already far behind to dedicate anywhere near that much to R&D, which means their offerings should suffer in comparison. That competitive advantage should enable Peloton to capture the lion's share of the home interactive fitness market.
Higher long-term margins
Peloton should be more profitable than Lululemon over the long term. Lululemon had a 22% operating profit margin in its last fiscal year. That's barely up from the 21% it achieved five years earlier.
In contrast, Peloton has seen huge margin expansion lately. Last quarter, its operating margin was 15%, up from negative 22% in the year-ago quarter. On every expense line item, Peloton is getting significantly more efficient.
For example, Peloton's subscription business already has high gross profit margins at 57%. But that should increase because content production costs are largely fixed. Those costs -- the instructors, the studio space, the production crews -- don't need to grow very much as subscription revenue grows. So today's 57% margin should approach 70% over time with further scale.
Second, the increasingly profitable subscription business should eventually become a larger revenue stream than the hardware business. That's because there should be tens of millions of paying subscribers while hardware should see moderating sales growth whenever the world eventually gets saturated with Peloton hardware. The much more profitable business becoming the majority of sales will only help profit margins.
Investors should consider Peloton the more attractive stock and consider buying it for the long haul.
