Lululemon Versus Athleta

Lululemon.com

To say Lululemon (LULU 3.70%) had a challenging year in 2013 would be an understatement. It had a list of missteps, but the one that everyone remembers, as well as the one that had the biggest impact on revenue, costs, and brand perception, was the launch of see-through Luon pants in March 2013. This unfortunate event opened the door for Gap's (GAP -2.10%) Athleta brand. Is Gap's Athleta brand going to kick that door down, or is Lululemon going to slam it right in Athleta's face?

See-through impact
Despite Lululemon's misstep with Women's Black Luon Pants (see-through pants), its revenue still increased 16% in fiscal-year 2013 over 2012. However, Lululemon opened 43 stores throughout the fiscal year. Therefore, revenue growth alone doesn't tell the whole story. numbers aren't the most reliable. If you want to really see how a company is performing, look at its comps numbers (sales at stores open at least one year).

For 2013, Lululemon delivered comps growth of 2%. If you add direct-to-consumer sales (online sales), then its comps improved 7%. For the first quarter of fiscal-year 2014, comps increased 1% year over year. However, direct-to-consumer sales pulled the weight, improving 25%, whereas comps at physical locations slipped 4%. This isn't necessarily a negative given the trend toward direct-to-consumer shopping, but it's still better to see gains in both areas. 

There have been a lot of concerns about Lululemon's corporate culture. This is why the company hired Laurent Potdevin as its new CEO. He's supposed to calm nervous investors and reestablish the company's image, but Lululemon just announced that it's reducing its adjusted earnings-per-share outlook for this fiscal year to $1.71-$1.76 from $1.90. It has also lowered its second-quarter sales projection to $375 million-$380 million from $387 million. This didn't calm investors, considering the 15% price drop in the stock price on the day of this announcement. But Foolish investors don't panic.

This doesn't mean Lululemon is a quality investment, but you should dig deeper to see if this recent hit could provide a long-term investment opportunity. Lululemon isn't just about yoga-wear anymore. The company has expanded its clothing lines to also target men, teens, and children. This doesn't guarantee future results (product expansion invites more competition), but this kind of diversification does increase the company's long-term potential.  

What's most interesting about Lululemon and its corporate culture is something that often goes overlooked. In the company's 10-K, it states that its pull back of see-through Luon pants in March of 2013 represents a commitment to quality. What a spin. The problem here is a lack of accountability, which needs to stop. 

That said, it doesn't seem like anything can get in Lululemon's way when it comes to customer loyalty. Lululemon offers yoga classes to its customers, and its salespeople are trained to form friendships with them. This leads to excellent customer loyalty, and one of the numbers below provides evidence for this.

Gap attack!
Gap's Athleta brand has a very simple strategy, which is to mimic everything Lululemon is doing and attempt to make it better. Currently, Lululemon has 225 stores, but while Athleta is currently at just 61 stores, it plans on having 100 locations by the end of this year. Given Gap's history of brand building, there is no doubt that it plans to have its Athleta brand surpass Lululemon in store count at some point over the next few years. Gap has many advantages in this contest that include marketing power, established business relationships, and experience. But Lululemon is still the leader, at least in one key aspect.

According to a recent report by Reuters, 55% of Lululemon customers are loyal to the brand. This considerably exceeds the 29% loyalty rate of Athleta. On the other hand, also according to Reuters, the average customer rating for Lululemon is 3.5 whereas the average customer rating for Athleta is 4.5. The takeaway is that Lululemon is doing a much better job at building relationships with its customers, which is what long-term sales is all about. 

Lululemon targets a more affluent consumer and charges $18 more on average than Athleta for a pair of yoga pants. This is despite the fact that both companies use very similar material. Lululemon's Luon pants are 86% nylon and 14% lycra. Athleta's Pilayo yoga pants are 88% nylon and 12% lycra.

Different roads
There is no clear and established winner in this contest yet. At the moment, it looks like both companies have strong potential to become long-term successes, but they're probably going to take much different roads.  

If you're looking for a roller-coaster ride with big upswings and painful drops, then you might want to consider Lululemon. This pattern should continue given the company's innovation and customer loyalty combined with its unpredictable company culture. If you're looking for a slow and winding train ride up a large mountain thanks to maturity, experience, and brand diversification, then you might want to consider an investment in Gap.