Who Doesn't Like Yoga Pants?

Nathaniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Over the last few years yoga pants have taken the country by storm as the apparel made its way into all aspects of life. At first primarily an athletic staple, yoga pants have become an everyday fashion option for many women. Lululemon Athletica (NASDAQ: LULU), a major yoga-related retailer, reported its first quarter earnings earlier this week, and the company was able beat analyst expectations while announcing a 7% increase in same store sales. 

However, shares slumped almost 18% as the company surprisingly announced that Chief Executive Officer Christine Day was stepping down from her position. Up to this point, Day has been very influential in Lululemon's success. As a result, a slew of investment analyst dropped estimates--an analyst from Sterne Agee downgraded  the company to a "neutral" from a "buy" and cut its price target to $75 from $90, citing in part "a lack of information regarding the future leadership of Lulu (that) is of great concern."

Lululemon, a high growth company, trades at forward multiples that are vulnerable should any fears set in. Going into earnings, the company was trading at a forward valuation over 40 times earnings--after Tuesday's drop the company is now trading at a more conservative valuation of 34.5 times forward earnings.  I believe that if innovation at Lululemon slows, a number of competitors stand ready to take the company's market share, in turn further slowing growth and lowering forward valuations. I would like to highlight a couple of cheaper alternatives to Lululemon that are already starting to gain market share.

Lets first compare Lululemon to a couple of competitors on a forward PEG basis. Investors can use the PEG ratio to determine if a stock may be overvalued or undervalued compared to the rest of the industry or sector. Generally, the lower the PEG ratio, the lower the valuation. Currently, Lululemon is trading at a PEG ratio far above that of its competitors Nike (NYSE: NKE) and Gap (NYSE: GPS).

Lets first take look at Nike, an athletic superpower with its hands in all aspects of performance apparel. Nike sells its selection of yoga pants for around $60, compared to Lululemon, which retails the majority of its pants for about $100. Nike may have lower pricing power now, but I remain confident in the company's ability to catch up in the yoga apparel industry. In addition, I feel more comfortable investing in a company that has established itself across a greater selection of merchandise. Analysts are expecting Nike to grow earnings by 27% this quarter and over 13% for the next two years. I would expect the company to further integrate its portfolio of proprietary material into its yoga apparel in the years ahead. 

Gap has been a great turnaround play over the last two years. This year alone shareholders have been treated to a return of over 35% on the back of strong earnings and renewed growth. The company has worked hard to reshape its image, and in the process created a great selection of yoga apparel. The company retails its yoga pants for about $50, almost half the cost of a pair from Lululemon. I fully understand the value of brand power, but still a 100% price difference is significant. Gap is trading at far more conservative forward multiple of of 15.42--rather inexpensive when you consider analysts are expecting the company to grow earnings at 16% this year. In addition, I like the international growth prospects ahead. The company to plans to open a net 80 stores this year, primarily in its Asia/Pacific business segment. An expansion into China should bode well for the company over the longer term.

Foolish Take

At these levels Lululemon looks far to0 risky for my portfolio. The company could possibly be heading into a period of substantial growth slowdown as a result of internal affairs and outside competition. I would rather see investors choose companies like Nike and Gap, which are far less expensive and offer a more diversified line of products. 

Lululemon has the potential to grow its sales by 10 times if it can penetrate its other markets like it has in Canada, but the competitive landscape is starting to increase. Can Lululemon fight off larger retailers and ultimately deliver huge profits for savvy investors? The Motley Fool answers these questions and more in its most in-depth Lululemon research available. Thousands have already claimed their own premium ticker coverage; gain instant access to your own by clicking here now.

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Nathaniel Matherson has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica and Nike. The Motley Fool owns shares of Nike. 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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