Succeeding in the apparel business is hard. Consumer tastes and the competitive landscape change constantly, which makes it difficult for investors trying to pick winning stocks.
If a company fails to keep its brand resonating with consumers, it is destined for trouble. Two businesses currently on opposites ends of the spectrum in this regard are lululemon athletica (LULU 10.29%) and Under Armour (UA 3.75%) (UAA 3.49%). The former has been a Wall Street darling, with its stock rising more than six-fold over the past five years. The latter seems to have lost its luster and has been attempting to turn itself around.
But the question for potential new investors today is which stock has the better long-term outlook from here?
Lululemon is thriving
Lululemon has been a hot stock, and for good reason. Its meteoric share price rise and soaring sales are partially the result of pioneering an athleisure trend with its beloved yoga pants.
From fiscal 2014 through fiscal 2019 (which ended Feb. 2, 2020), revenue grew at a compound annual rate of 17.2%. After sales dipped by 16.7% in Q1 2020 due to pandemic-related store closures, Lululemon returned to growth. The $1.5 billion in revenue it reported for its most recent quarter was 22% higher than the prior-year period.
Unlike other athletic apparel makers, Lululemon's business is vertically integrated, so it maintains control over everything from the design specifics of its garments to the point of purchase by shoppers. The bulk of its revenue is generated from a worldwide portfolio of company-operated stores, as well as its direct-to-consumer e-commerce channel.
Bolstering Lululemon's remarkable success is a community-based marketing strategy, driven by brand ambassadors who build word-of-mouth promotion. Having an immediate relationship like this with customers supports the company's strong brand presence. Its effectiveness is proven by its gross margin, which in fiscal Q3 2020 was 56.1% -- higher than either Nike or adidas. That demonstrates the premium customers are willing to pay for Lululemon's products.
Operating from a position of strength, Lululemon can afford to be aggressive. Its $500 million purchase of Mirror gave it an entry into the lucrative at-home fitness space, pitting it against the formidable Peloton. Although it's way too early to make any predictions about how that will play out, it presents Lululemon with a valuable opportunity to cross-sell and gain from potential synergies between athletic apparel and fitness equipment.
Under Armour is trying to right the ship
The situation for Under Armour is quite different. With most of its revenue coming from wholesale channels, it's difficult to keep tight control over inventory. Previous struggles with product distribution led to the CEO of Dick's Sporting Goods calling out Under Armour in 2018 for being the cause of soft sales at his company's stores. Such issues weaken Under Armour's brand image, and the company is still trying to fix them.
As Lululemon gobbles up market share, Under Armour is fighting to maintain its position. Third-quarter sales were flat compared to the prior-year period. There were some positives though. Its gross margin of 47.9% was healthy, and e-commerce revenue jumped by more than 50%. It seems a rising tide -- in this case, the growth of online shopping -- does lift all boats, even Under Armour.
So, what does the future hold? On the most recent earnings call, CEO Patrik Frisk highlighted the women's apparel business as a key growth opportunity for his company. But this is where Lululemon absolutely outshines the competition. Under Armour failed to capitalize on the athleisure trend, and now it's left trying to play catch-up against companies that have much stronger customer mindshare. It'll be interesting to see what sort of progress it makes here.
Management is spending a whole lot of time trying to correct past mistakes. In addition to inventory and brand challenges, Under Armour is still attempting to move past the accounting issues that occurred when founder Kevin Plank was CEO. Furthermore, it was recently announced that the company is selling MyFitnessPal at a loss compared to the price it paid more than five years ago.
While Lululemon conducts business with a high-octane offense, Under Armour must play defense as it works to overcome its blunders. It can't keep up in apparel, and the MyFitnessPal divestiture indicates that it's giving up in connected fitness.
Quality wins in the end
As a long-term investor focused primarily on quality, Lululemon is my better buy.
In the apparel business, having a powerful brand that connects with consumers is a competitive advantage. Lululemon is clearly getting stronger here, as evidenced by its robust sales growth and DTC expertise. Because of this, I do not think the stock is overvalued today at 11 times sales. Furthermore, the 9% dip in the stock over the last month provides an attractive entry point.
If, however, you expect a turnaround to happen, Under Armour might be your play. It's no doubt that the stock has been beaten down over the years, but I think its current valuation of two times sales is warranted given the company's poor competitive positioning and recent string of operating losses. It's difficult to turn around a brand that has weakened, and even harder for investors to try and time when this will happen. In the words of Warren Buffett, "Turnarounds seldom turn."