The sports apparel industry can be incredibly lucrative. Some of the biggest and most profitable brands can be found in the space, including NIKE, Inc. (NYSE: NKE) and Adidas AG (DE: ADS). In this piece, we are looking at two smaller companies in the industry, Lululemon Athletica (NASDAQ: LULU) and Under Armour (NYSE: UAA) (NYSE: UA), whose niche brands gained significant ground over the past decade against their more established competitors. However, only one of the two appears financially robust these days. I go over why Lululemon is likely the better play here.
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Accordingly, I am bullish on LULU stock and neutral on UA stock.
Which Brand Has Better Prospects?
Both Lululemon and Under Armour have built very strong brands in their respective categories.
Lululemon has established its dominance on quality yoga outfits known as Luon. They dry off sweat easily so that the user can stay comfy even in hot conditions. In fact, Lululemon’s leggings have become the go-to option for consumers in this premium product category, allowing the company to attain incredible pricing power.
The company has more recently leveraged its strong pricing power to expand its presence to other apparel categories, going after the same premium consumer target group.
On the other hand, Under Armour is known mostly for its high-performance athletic gear, focused on reliability and performance optimization.
The company has done a great job building a strong brand by partnering with iconic athletes. Among them is Dwayne “The Rock” Johnson, whose unmatched influence has been a pillar for Under Armour’s credibility overall status.
Overall, building a strong brand in the industry is everything. At the end of the day, anybody can design and produce running shorts, t-shirts, and leggings. There is pretty much nothing proprietary here.
Strong branding, accompanied by meeting the relevant quality standards a company actually advertises for, is the secret sauce to success. Still, building strong brands at scale is incredibly hard and, most importantly, super expensive.
Anyhow, I believe both companies have built equally-strong brands in their respective categories and are appreciated equally by their separate target groups. With that in mind, let’s check which one of the two is doing better financially.
Lululemon’s Financials are Remarkably Better
What makes Lululemon a better pick over Under Armour relatively easily is its tremendous financials. As far as the company’s public data goes, going back to 2005, revenues have grown every year with no exception.
That’s a prolonged trend of serial revenue growth, which could imply that the company is entering a maturity phase. Yet, the company’s five-year revenue growth compound annual growth rate currently stands at 21.7%, showcasing robust momentum and little to no signs of any alarming slowdown.
Simultaneously, the company has managed to remain extremely profitable, suggesting vigorous organic growth and mindful advertising spending. To provide some context here, Lululemon’s EBITDA margins have been hovering between 25% and 30% over the past decade. In the meantime, Nike’s and Adidas’ EBITDA margins have averaged close to 15% and 10% despite Lululemon clearly having inferior scale and production capabilities against such industry giants.
When it comes to Under Armour, things seem less exciting. The company did achieve record revenues last year, but revenue growth has clearly slowed down dramatically. The company features a five-year revenue growth CAGR of just 3.3%.
Additionally, its bottom line has failed to flourish. With EBITDA margins struggling to stay above 10% over the past few years and interest expenses on debt adding additional weight on what could otherwise be somewhat acceptable profitability, net income margins have barely been positive. In fact, the company reported losses in 2017, 2018, and 2022.
I believe this is due to the company over-extending its ad spending against decelerating revenue growth to remain relevant, which has led to less room for margins to breathe. Last year, ad expenses advanced by 18.2% alone. The fact that, unlike LULU, UA hasn’t managed to expand to other categories is also worrisome regarding its future growth avenues.
What is the Price Target for LULU Stock?
Turning to Wall Street, Lululemon has a Strong Buy consensus rating based on 18 Buys, two Holds, and one Sell assigned in the past three months. The average Lululemon price target of $397.82 suggests 23.8% upside potential.
What is the Price Target for UAA Stock?
Wall Street’s sentiment for Under Armour is relatively more mixed, with the stock attracting a Moderate Buy consensus rating based on five Buys, 10 Holds, and one Sell assigned in the past three months. Nevertheless, the average Under Armour price target of $10.31 suggests 43% upside potential.
Conclusion: Go for the High-Quality Option
Wall Street estimates point toward significantly more upside for UAA stock. This is likely because the stock appears substantially cheaper on paper. Specifically, UAA shares trade at a forward P/E ratio of 11.4x (for the next 12 months), implying a heavy discount compared to LULU’s forward P/E of ~28x.
That said, I would much rather pay a premium multiple for a company growing at 20%+ while retaining industry-leading margins than buy into what appears to be a discount today, which ultimately won’t even matter if UA remains unable to show meaningful margins over the medium term.
Anyhow, with UA’s growth momentum fading and ad costs rising, I would most certainly be skeptical about whether its investment case is viable, moving forward.
