Billionaire Stephen Mandel Thinks the Sheerness Issue Is Sheer Nonsense

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Billionaire Stephen Mandel's Lone Pine Capital recently upped his stake in Lululemon Athletica (NASDAQ: LULU); he now owns 5.6 million shares, or 5.01% of the apparel company's outstanding shares. Mandel's recent purchase is a 16.5% increase from the shares that Lone Pine owned at the end of 2012.  

Mandel has some $17 billion of assets under management and is a Tiger cub. Mandel left Julian Robertson's Tiger Management in 1997 to launch Lone Pine, a fund that employs a “bottom-up” strategy for picking stocks.

The big news for Lulu of late was the mid-March announcement of a potential shortage in its supply of black Luon pants. This was due to the fact that a number of shipments had to be pulled from shelves because they failed to meet technical specifications (the sheerness issue). After briefly dropping below $63 per share on news that it would be recalling a number of yoga pants, the stock is now back up to pre-recall levels, above $68 per share.

Lulu also managed to post EPS last quarter that came in at $0.75, compared to $0.51 for the same period last year. This was on the back of 10% higher same- store sales and 31% higher revenue. The company also expects to post first- quarter revenue between $333 million and $343 million after accounting for lost revenue in the range of $12 million to $17 million due to the black-Luon issue. 

I still have my reserves about Lulu, given that its niche business model and risks related to expanding into other markets. Lulu's future appears to be rooted in its eventual transition into general athletic wear and not just women's yoga clothing. However, that market is already ripe with real apparel suppliers, including the likes of Under Armour (NYSE: UA), Adidas and Nike (NYSE: NKE).

Is there a better way to invest in apparel? 

Under Armour develops and distributes apparel, footwear and accessories. Apparel is expected to continue to be the revenue driver, accounting for more than 75% of the company's revenue.

According to Standard & Poor's, the synthetic performance-apparel market is around $3 billion, with Under Armour owning some 60% of that market. What's more is that the company introduced cotton performance apparel in 2011, which expanded its addressable market to include the $12 billion active-use sports apparel market. Under Armour is also still limited geographically (especially compared to Nike), getting more than 95% of its revenue from North America.

Under Armour also announced first-quarter earnings results earlier this month, announcing that revenue increased 23% year-over-year. However, net income was down 47% due to an increase in marketing expenditures.

The retailer now expects 2013 net revenue to come in at around $2.2 billion, representing growth of as much as 22% over 2012. It expects 2013 operating income between $256 million to $258 million, representing growth of 23% to 24%.

Nike designs and develops footwear, apparel, equipment and various accessories. Although most people consider Nike a shoe company, it's really much more than that; around 60% of Nike's revenue is derived from footwear, but some 30% comes from apparel.

Nike managed to beat fiscal third-quarter earnings expectations handily by posting EPS of $0.73, above the Street's $0.67 estimate. This comes as the future order growth for March to July 2012 grew robustly (up 7%) year-over-year.

After the earnings beat, UBS reiterated its buy rating, noting that gross margins were impressive, as Nike's gross margin expanded 30 basis points sequentially during the quarter versus UBS' estimate for a 10 basis-point contraction.

Nike is also one of the top consumer stocks loved by hedge funds. Although the slowing Chinese economy has caused some concern for companies operating in the region, Nike only derives 12% of its revenue from greater China. Nike gets around 40% of revenue from North America, 20% from western Europe and 16% from the emerging markets. This is unlike Lulu, which gets almost 95% of its revenue from the U.S. and Canada. 

Don't be fooled

All of these apparel companies have solid balance sheets and impressive growth prospects in their respective markets. They all have debt ratios less than 10% and quick ratios above 2.0. However, from a valuation standpoint, Nike appears to be the best bet.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>Lululemon</strong></p> </td> <td> <p><strong>Under Armour</strong></p> </td> <td> <p><strong>Nike</strong></p> </td> </tr> <tr> <td> <p>Forward P/E</p> </td> <td> <p>29</p> </td> <td> <p>30.5</p> </td> <td> <p>20</p> </td> </tr> <tr> <td> <p>Price to sales</p> </td> <td> <p>7.2</p> </td> <td> <p>3.2</p> </td> <td> <p>2.2</p> </td> </tr> </tbody> </table>

What's more is that Nike has the lowest volatility, with a beta of approximately 0.9, compared to Lulu's 2.1 and Under Armour's 1.5. Nike would be a solid investment from a valuation perspective, yet Lulu could provide solid growth opportunities, assuming it can effectively transition beyond its niche women's yoga-pants market.  

Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica, Nike, and Under Armour. The Motley Fool owns shares of Nike and Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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