Retailers lululemon athletica (LULU -0.98%) and Nordstrom (JWN 0.24%) have been on two different tracks. Lululemon stock price has climbed 418% over the last three years, while Nordstrom's share price has dropped 61%.
Lululemon offers plenty of growth opportunities, but the question is whether Nordstrom also has some growth opportunity and its stock is cheap enough to warrant a better buy right now. Let's compare the investment case for each stock to find out.
Why Lululemon is a great growth stock
Lululemon continues to show why it's a star in the making in the athletic-apparel industry. Even while its stores were closed during the pandemic, Lululemon's direct-to-consumer channel (which includes e-commerce) grew 155% year over year in the fiscal second quarter. Online sales comprised 61% of the business, helping Lululemon post a slight increase in total revenue despite the loss of store traffic.
Image source: Getty Images.
Lululemon is still small for a sportswear brand, even though it's experienced growth over the last 20 years. It just hit $4 billion in revenue in fiscal 2019, which isn't much compared to the approximately $300 billion that's spent every year on athletic wear.
What's more, Lululemon still has a massive opportunity to grow awareness with men. This category makes up a fifth of total revenue right now but has been growing much faster than the women's category in recent years.
The company is also in the early stages of expanding internationally. Revenue from outside of North America made up 17.6% of total revenue last quarter, but it remains the fastest-growing segment. Lululemon remains on track to quadruple international revenue in the next five years, with China and Europe being the two areas of focus.
With so much room to expand around the world, Lululemon should continue growing revenue at double-digit rates when the economy fully recovers from the pandemic. Profits should grow even faster, given that the direct-to-consumer business continues to grow into a larger portion of overall sales and generates a significantly higher operating margin than sales at physical stores.
Image source: Nordstrom.
Why Nordstrom could be a compelling value stock
Like Lululemon, Nordstrom's physical stores were hit hard during the pandemic, with sales chopped nearly in half. However, with the economy showing signs of a strong recovery, Nordstrom should see results strengthen in the second half of the year.
Nordstrom shifted its anniversary sale from the fiscal second quarter to the third quarter, which should improve sales and move more inventory. Although the store closures crushed the bottom line, management had inventories in line with demand heading into the fiscal third quarter, which paves the way for a much better performance heading into calendar 2021.
As the economy recovers, Nordstrom should see profits rebound strongly next year. It's on pace to save at least $200 million in expenses this year. Currently, the consensus analyst estimate has Nordstrom delivering adjusted earnings per share of $1.49 next year. That puts the stock's forward price-to-earnings ratio (P/E) at a cheap 10.7.
The only problem investors need to worry about is the potential for a value trap. Unlike Lululemon, Nordstrom doesn't have the opportunity to grow by opening new stores. It will have to rely on margin improvement to deliver earnings growth and returns to investors. On that note, during the fiscal second-quarter conference call, CEO Erik Nordstrom explained that the business is now "leaner and more efficient" and is now "pivoting to prioritize market share gains and profitable sales growth."
One of the company's best growth opportunities is through its digital channel. Digital sales made up 61% of the business last quarter, as consumers shifted to online shopping. Management has made a lot of investment in this channel in recent years, which led to curbside pickup comprising 15% of Nordstrom.com sales last quarter.
Unlike Lululemon, Nordstrom's digital business wasn't enough to offset the decline from store sales. Still, along with the Nordstrom Rack off-price business, the digital channel will be a valuable weapon going forward, as Nordstrom looks to gain market share against other department stores that are not faring as well.
Which is the better buy?
The decision depends on whether you're looking for a long-term compounding machine or a value stock that could outperform in the short term. The decision is more difficult given that, despite Lululemon's strengths, the stock is richly valued now.
After a 45% rise year to date, Lululemon's forward P/E stands at a frothy 79. Its price-to-sales (P/S) multiple has stretched from around 7.5 at the beginning of the year to 11.4.
Nordstrom trades at a dirt-cheap P/S ratio of 0.20. The share price has fallen 61% from its highs in January. As the business shores up its profitability over the next year from a combination of cost savings and improvement in store traffic, the stock could bounce back.
Most investors are better off sticking with potential wealth-builders like Lululemon that can keep growing for many years. The yoga enthusiast is on offense, expanding into international markets and exploring new revenue streams, such as the recent acquisition of MIRROR, which puts the company in a position to enjoy explosive growth in the interactive fitness market.
If it were my money, I would forget cheap department-store stocks and start a small position in Lululemon.
