Should Investors Trade in Their Lululemon Athletica inc. (LULU) for Competing Stocks? – The Gap Inc. (GPS), Under Armour Inc (UA)

The third week of March proved to be interesting for investors in the sports apparel space. Shares of Lululemon Athletica inc. (NASDAQ:LULU) dropped, while shares of NIKE, Inc.. (NYSE:NKE) and Under Armour Inc (NYSE:UA) surged. Should traders swap their Lululemon for Nike or Under Armour?

Lululemon Athletica inc. (LULU)

What’s Lululemon’s problem?

The maker of yoga apparel tumbled after the company cut its guidance. About one-fifth of Lululemon Athletica inc.’s black yoga pants — arguably the company’s flagship item — were found to be too see-through. The company announced a recall on pants purchased after March 1.

Lululemon Athletica inc. (NASDAQ:LULU) shares have been priced for tremendous growth, so any change to guidance can be devastating. Even with the sell-off, Lululemon still trades with a price-to-earnings ratio of 33 — which is about 80% greater than the S&P 500’s 18.

But to make matters worse, a number of analysts cut their price targets on the stock. Credit Suisse lowered its price target to $75 from $79, warning that the company could be in danger of facing “longer-term consumer backlash” from the recall.

Stifel Nicolaus did the same, also lowering its price target to $75. Analysts there believed that the company’s brand could be compromised by the recall. Bank of America was most grim, lowering its price target to $60. However, the bank has been bearish for some time, as it merely reiterated its underperform rating.

The price target cuts speak to Lululemon’s real threat: that the recall could damage the company’s reputation among consumers. As Lululemon charges $98 for a pair of its yoga pants and rarely offers discounts, any perceived lack of quality could wreak havoc on Lululemon.

Gap (NYSE:GPS), Under Armour, Nike coming after Lululemon’s business

Lululemon Athletica inc. (NASDAQ:LULU) faces competition from at least a dozen companies, as there are numerous makers of athletic and yoga apparel. But some companies pose a more significant threat than others. The Gap Inc (NYSE:GPS)’s emerging Athleta brand might be the most direct competition.

As Bloomberg notes, The Gap Inc (NYSE:GPS) has been going after Lululemon directly, opening up dedicated Athleta stores near Lululemon locations and undercutting the Canadian company on prices, while following a similar business model.

Then there are the other athletic clothing giants: Nike and Under Armour Inc (NYSE:UA). Lululemon has had the edge on these in its core market, as both have tended to emphasize men’s clothing over women’s. But recently, both have making attempts to bolster their women’s segments.

Nike has been pushing the women’s running business. On the company’s earnings call, Charlie Denson, the president of Nike’s brand, said that the women’s running business is “incredibly strong.” Denson hopes to bring that strength into all of Nike’s women’s apparel, stating that “the new presentations that you’ve seen in women’s training in some of the stores certainly has resonated with the consumer.”

For its part, Under Armour has begun to redesign its stores to appeal to female consumers. Under Armour’s retail locations generally look dark and locker-room-esque. New stores will be brighter and feature more mannequins. In addition, the company has taken PR steps, including partnering with the USA gymnastics team.