Buy Nike over Lulu Now?

Nike (NYSE: NKE) stock has declined by close to 8% since early February after the WHO declared the Coronavirus a global health emergency, while  Lululemon (NASDAQ: LULU) stock has also lost around 7% of its market capitalization. The lockdown in various parts of the world has hurt the apparel industry worldwide, with more weakness to come over the coming months. The companies have had to shutter their stores temporarily, and the stores are expected to remain closed until the end of May, as the pandemic continues to spread, particularly in Europe and the U.S., which are the largest markets for apparel companies. However, we believe Nike has the edge over Lululemon and is likely to fare better over the coming months because of its stronger brand presence (geographical diversification), robust digital network, and a diversified business model as compared to Lululemon. This is one of the reasons that since March 23, Nike stock has rebounded more than 40% while Lululemon’s stock has gained less-around 30%. See our detailed dashboard analysis, ‘Is Lululemon Athletica Expensive Or Cheap vs. Nike?’

Nike is uniquely placed in the apparel industry. Nike’s strong digital presence and geographical reach have helped the company carve a niche position in the apparel market. Nike’s products are sold across the globe while it has a well-developed digital channel in more than 45 countries. Additionally, Nike’s activity apps have increased user engagement and provided a boost to the company’s digital sales. Despite the outbreak of coronavirus, Nike’s digital business grew 30% in China in Q3 2020 (ending February). Nike’s China retail business has also gained steam, as the company has reopened all its stores in China. Notably, China is Nike’s fastest-growing and most profitable segment.

On the other hand, Lululemon is one of the fastest-growing apparel companies, with the company witnessing an annualized revenue growth in excess of 17% over 2014-2019. However, Lululemon has certain limitations as compared to Nike which will hurt the stock in the near term. As of 2019, Lululemon was operating close to 491 stores while Nike’s store count stood at around 1,152. Moreover, Lululemon primarily offers athletic apparel products, whereas Nike’s product portfolio ranges from footwear, apparel, and even equipment and accessories.  In addition to that, Lululemon derives more than 85% of its revenues from North America while Nike’s exposure to North America was around 40%. Notably, the continent has been one of the worst impacted regions due to the outbreak. Overall, we believe that Nike would outperform Lululemon over the coming months due to the reasons highlighted above. Our conclusion is supported by our detailed dashboard analysis, ‘Is Lululemon Athletica Expensive Or Cheap vs. Nike?’ wherein we compare trends in key metrics for the two apparel companies over the years to determine their relative valuations under the current circumstances. We summarize parts of this analysis below.

There Is Little To Separate The Stock Performance Of Both Companies Over Recent Weeks

Nike’s P/E based on 2019 earnings has declined from 39.6x in 2019 to 35x currently, while Lululemon’s multiple has declined from 47x to about 45x. The steeper decline in Nike’s multiple was due to uncertainty around Nike’s China business, as Nike has significant exposure to the country. However, the uncertainty has now settled, with China’s business gaining momentum and as a result, we believe Nike’s multiple is appropriate at its current level. On the flip-side, Lululemon’s multiple still appears high, considering that the company’s revenues and margins are at a greater risk compared to Nike’s. Specifically, Lululemon’s P/E is similar to the highest level seen in the last six years- indicating that the market hasn’t quite priced in the negative impact of weaker revenues and margins on the company’s stock. This leads us to believe that LULU stock could be vulnerable. Overall, it’s likely that Nike stock will outperform Lululemon, which will potentially see its P/E multiple shrinking further when the ground reality is confirmed during its fiscal Q1 results.

But How Long Will Lululemon Stock Remain Under Pressure?

• The expected timeline for recovery in global economic conditions, and in Lulu’s stock, hinge on the broader containment of the coronavirus spread. Our dashboard forecasting US COVID-19 cases with cross-country comparisons analyzes expected recovery time-frames and possible spread of the virus.
• Further, our dashboard -28% Coronavirus crash vs. 4 Historic crashes builds a complete macro picture and complements our analyses of the coronavirus outbreak’s impact on a diverse set of Lululemon’s multinational peers, including Gap and American Eagle. The complete set of coronavirus impact and timing analyses is available here.
• We believe there will be a recovery in demand for most sectors by late May/early June, with the gradual lifting of lockdowns and a gradual rise in the number of COVID-19 cases remaining within the manageable capacity of hospitals and care providers.
• Although most companies will report poor results starting mid-July, market expectations will be buoyed by a visible improvement in the situation on the ground.

While things are bad for companies across the apparel industry, the ongoing crisis has raised questions about the very survival of some companies due to their precarious financial position. We find out whether Gap Can Survive The COVID-19 Recession in a separate analysis.

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