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?
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.
Can Lululemon keep its cult following?
Investors who wish to remain in Lululemon Athletica inc. (NASDAQ:LULU) should be confident that the company can maintain its image. To remain successful, Lululemon must continue to convince consumers to fork over $98 for a pair of yoga pants. For customers to pay that price, they must remain confident that they are receiving the highest quality of clothing.
On the other hand, the sell-off might make Lululemon shares a bargain at current levels. Although the PE ratio is high, it is still much lower than Under Armour Inc (NYSE:UA)’s 42 and only a bit higher than NIke’s 27. In addition, the scandal over the yoga pants has caused a great deal of free advertising — both in the press and on social media.
Ultimately, investors must decide if they believe the company can maintain its cult following. If it can’t, Nike and Under Armour — both of which are increasingly targeting women — could be better buys.
The article Should Investors Trade in Their Lululemon for Competing Stocks? originally appeared on Fool.com and is written by Salvatore “Sam” Mattera.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.