More Downside Likely Ahead for Lululemon

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Lululemon Athletica (NASDAQ: LULU) is once again facing a legal battle due to the recall of its see-through black Luon yoga pants.

The new filing from major U.S. law firm Morgan & Morgan was announced on July 5, and alleges that Lululemon didn't fully disclose several shortcomings that led to an inflated share price. The lawsuit is on behalf of people who bought shares of Lululemon between March 21 and June 10. The suit claims defects made the pants see-through due to the firm's attempt to increase its net profit by cutting costs.

The company is also facing class action suits from Houssam Alkhoury, and Hallandale Beach Police Officers and Firefighters' Personnel Retirement Fund. That is related to the company increasing possible executive bonuses before the recall. 

These suits cast a very dark shadow over the company's shares, as it faces the costs associated with the recall and paying many possible settlements. The recall alone cost an estimated $60 million according to a report from CTV News. 

Lululemon faces further issues with the founder, Dennis Wilson, saying he plans to sell up to 3.4 million shares of the company according to an SEC filing. That would reduce his stake from 28% to 25%. While I don't take insiders selling stake in the company too seriously (we all have reasons for needing funds), the timing of the sale could indicate Wilson sees the lawsuits, recall and loss of the firm's CEO as having a negative effect on the company. 

Where to put your money?

Nike (NYSE: NKE) is one of the fastest growing companies in the developing world. Unlike Lululemon, its brand isn't confined to the fashion trends of the Western market. Shoes and other apparel sell well in China as well, though the firm is struggling to increase sales in that country. The firm also expects revenue to come from the Middle East. However, right now the products are too expensive to generate major profits in these areas, but along with the growing middle class will be a greater ability for the average citizen to afford the company's products.

The firm has a P/E ratio of just 25, but its growth rate is rapid. In just the last three years, the firm has managed to send a jolt to its revenue by increasing it from $19.17 billion to $24.12 billion. Furthermore, the company projects earnings of $3.42 in 2014 and $3.84 in 2015. 

Foot Locker (NYSE: FL) is experiencing a tremendous amount of same-store sales growth, and this has led to the earnings per share forecast increasing nicely. Analysts believe the company will earn $2.83 per share by the end of next year and $3.12 in 2015. That represents a P/E ratio growth of nearly 15% next year and almost 10.5% in 2015.

I am also bullish on Foot Locker because of the company's selection of name-brand shoes that many teenagers and adults gravitate towards. The teenage segment still has growing feet, and they will need new shoes after they have outgrown the pair they are currently wearing. That creates a cycle of customers for the company.

Finding the best apparel company

Lululemon's ship could very well be sinking. It's at least a firm that will likely have unusual expenses related to lawsuit settlements in the years ahead. That's not likely to make a massive impact on potential net profits, but the series of people close to the company jumping ship is cause for concern. After all, in addition to the founder appearing to be positioned to sell a significant portion of his holdings in the company, the firm also lost its long-time CEO and is on the hunt for her replacement.

Lululemon is being tested right now, and could very well end up coming out back on top, but Nike and Foot Locker are much safer places to put your money for probably the next couple years.

Phillip Woolgar 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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