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Under Armour vs. Lululemon: A Tale of 2 Apparel Companies

In this clip from the Industry Focus: Consumer Goods podcast, Sean O'Reilly, Mark Reeth, and Vincent Shen go over this past quarter's earnings for lululemon athletica (NASDAQ: LULU) and Under Armour (NYSE: UA).

Find out how Lululemon is managing a gross margin of around 50% (and why this figure is steadily declining), how the athleisure-wear space is seeing increased competition, and why Under Armour is much better prepared to handle the competitive pressure. Our trio also assesses Lululemon's plans to double sales by 2020 and talks about one unexpected area in which Lululemon is seeing growth.

A transcript follows the video.

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This podcast was recorded on April 26, 2016. 

Sean O'Reilly: Mark, you get to pick. We're going to talk about clothing now.

Mark Reeth: Clothing!

O'Reilly: Do you want to talk about everybody's favorite yoga-wear retailer, Lululemon, or Under Armour first?

Reeth: That's a good question. I guess we'll start with Lululemon. Again, I took a look back at the share prices a year ago. Lululemon's only up 2% since we probably last spoke about it. And the conversation, for a long time, with Lululemon was trouble with the management.

O'Reilly: Pilling.

Reeth: Pilling, for instance, was also a problem a year or go or so. Those problems have kind of been pushed to the side, and Lululemon was still doing what they usually do. And to their credit, revenues are up 15%, net income is up 11% as of their last quarterly filings. They're still firing on all cylinders.

O'Reilly: It does seem like, operationally, they're turning the ship finally.

Reeth: Exactly. And that's very good. There's nothing wrong with that. My problem is, it's going to be tougher and tougher for Lululemon to sell these $80 capris and $110 hoodies.

O'Reilly: Do you remember the company's gross margins? It's like 50%! That's insane!

Reeth: Yeah, and that's something I was going to mention -- they've started guiding gross margins down, very slowly. I think yeah, gross margins last quarter were something like 51.4%. They guided for gross margins to come down to 47%.

O'Reilly: This year?

Reeth: Yeah, this quarter, year over year. That's a small amount, in the long-term scheme of things. And like you said, 51%, that's pretty good. But it's indicative to me that their gross margins are going to start to, at least in my mind, slowly come down as more and more competitors enter this market. A year ago, if we talked about athleisure or whatever the kids are calling it these days, we probably just talked about Lululemon. Maybe Gap, with their athletic stores, sure.

O'Reilly: You're absolutely right.

Reeth: Now, if we're going to have a conversation about Lululemon, a lot of other companies have to enter that conversation. Nike is coming at the athleisure wear space from the sports angle. Excuse me, Under Armour, which we'll talk about in just a second, same thing.

O'Reilly: I was just thinking, since we did our last show together, a mall in my hometown in the Midwest, huge Under Armour store just opened up. Shoes, yoga pants, shirts, huge store. And I'm like ... there's only so many consumer dollars out there.

Reeth: That's true, but you have to admit, a lot of those consumer dollars are going to Under Armour right now. If you look at their last quarterly report, I mean, my god! What is it, revenue growth of over 20% for the last 24 consecutive quarters? You can't deny they're doing something right over there. But, again, Under Armour is almost in the same position as Lululemon. I think Lululemon is a little bit worse off, because their niche is so much more niche-y, that it's not just leisure wear, it's also mainly women's leisurewear, whereas Under Armour can expand out of its niche a little bit easier, I think. 

But again, there's just so much competition coming in to this market now, where we're starting to see a lot of saturation. If you look, actually, at Under Armour's pricing over the last couple of quarters, a Morgan Stanley analyst named Jay Sole pointed out in a report recently that Under Armour has seen declines in the average selling price of the company's apparel for the last six quarters. Again, it's almost like that Lululemon guiding down their gross margins just a little bit. Everyone's focused on the big numbers. The revenue is outstanding, the EPS is great. 

And sure, that's all fine. But there are little hints here that the saturation is starting to affect these companies. Under Armour is bringing prices down, Lululemon's gross margins are starting to get hit just a little bit. These businesses aren't going to collapse tomorrow, by any stretch of the imagination. But again, when you have so many competitors coming in from every single angle into this market, whether it's low-end with Wal-Mart and Target, or high-end with Victoria's Secret or Tory Burch ... Beyonce has her own athleisure line. For God's sake, people, Beyonce. 

O'Reilly: Do you know what she charges? [laughs]

Reeth: No, I don't, I'd have to check the price tag on everything in my closet. But, again, I think both of these companies are pretty sound. But I think the market as a whole is starting to get really crowded.

O'Reilly: Not only that, but Lululemon's having to go to different segments for growth. The best, fastest-growing segment for Lululemon in the quarter they just reported was men's wear. So, my question was, does anybody here own a shirt from Lululemon? No?

Reeth: No ...

O'Reilly: Didn't think so.

Reeth: And that kind of goes to the point I was trying to make earlier, though, how Lululemon is kind of backed into this corner with their niche. It is very much a women's brand for leisure wear. And you're right, they are trying to grow out of that into men's wear. And again, to their credit, their online sales have been ticking up pretty consistently over the last couple of quarters. Like, they're doing things right. But it's tough to have that conversation. I'm not going to walk into a Lululemon on my own and buy sweatpants there.

O'Reilly: Girlfriend's going to have to drag you in there. [laughs]

Reeth: It's not my brand, it is my girlfriend's brand, or your wife's brand, or your daughter's brand, whatever. And, as for Under Armour, they don't really have that. They have that leisure wear as a sportswear kind of market. And they actually have so much more room to grow in several markets, like their footwear, which has been outstanding for Under Armour in these last couple quarters. We've got Stephen Curry, who's just been phenomenal, and he's been their biggest brand ambassador, his footwear line is selling hand over foot. Their footwear segment grew 64% year over year this past year. They have new launches, smart running shoes, new golf shoes with Jordan Spieth as their spokesperson. So I think Under Armour, like I said before, has a lot of different directions it can grow. Lululemon, not nearly as many. And that worries me.

O'Reilly: Yeah. In their latest report, Vince, I'd love to get your thoughts on this, they said they wanted to double sales by 2020. My eyeballs popped at that. Mark here is not buying it. I mean, maybe they can sell to a bunch of men? Is this possible? They want to double sales by opening stores and stuff ...

Vincent Shen: Yeah, but keeping in mind what you guys said in terms of the market being really crowded, I will not deny that, especially in the athleisure segment, within, we'll call it sporting apparel overall, definitely getting very crowded. I understand that. But Lululemon's footprint is still quite small -- 350 stores. And mostly concentrated in the U.S. at that. You mentioned men's growth as being a big driver for them, but also international growth is a big driver for them. So I think that's very ambitious on their part. But at the same time, there's also some longer-term trends in terms of demographics that are benefiting them as well.

Morgan Stanley, again, had this report talking about sporting retail, about the fact that in North America, for example, high school sports participation is up from 25% to 35% over the past 35 years, especially with girls, which benefits Lululemon. Participation doubled from 17% to 32% over the same period. Then, keep in mind the fact that U.S. professional sports leagues, their studies say that interest in their product, their sports, is very much tied to the fact that the consumers participated when they were younger. That doubles up as it goes through time.

Latin America, super-low penetration. Does that benefit an Under Armour more so? Probably, because the premium prices aren't going to work as well in some of these emerging markets. But, overall, I think that, with China, for example, another big growth area for both of these companies, and the fact that the government there is actually pushing its citizens into healthier lifestyles, to be active, because they basically want a next generation of highly competitive athletes to participate --

O'Reilly: Are they actually telling them to work out? 

Shen: They're very much pushing them.

O'Reilly: That's scary. [laughs] Big Brother is telling you to work out. [laughs]

Shen: I don't think that's the worst thing in the world. 

O'Reilly: Yeah.

Shen: So that's a nice push to have. Basically, think about basketball. The number of people who play basketball in China is absurd per day; it's hundreds of millions. So when you have a market that size, I see the competition, of course, just being the fact that the market is so strong that people want to get into this business.