In this article, we will examine two well-known brands in the athletic apparel and footwear industry: Nike (NKE) and Lululemon (LULU).
Nike, a global leader in sports apparel, footwear, and equipment, is one of the most recognizable brands worldwide since its establishment in 1964. Offering a diverse range of products for various sports and activities such as running, basketball, soccer, golf, tennis, and fitness, Nike has established itself as a household name. In addition to its own brand, Nike also owns other well-known labels including Converse, Jordan, and Hurley.
On the other hand, Lululemon has made a significant impact on the market in recent years as a relative newcomer. Founded in Vancouver, Canada in 1998, Lululemon is a Canadian-American company that specializes in technical athletic apparel for activities such as yoga, running, training, and other fitness pursuits. With its expansion to over 650 stores worldwide, Lululemon has gained a strong foothold in the industry, offering high-quality products that prioritize performance, comfort, and style.
Nike’s market reach extends worldwide, with a strong presence in major regions such as North America, Europe, the Middle East and Africa (EMEA), Greater China, Asia Pacific, and Latin America (APLA). Similarly, Lululemon operates in multiple countries, with its largest presence in the United States, Canada, and China.
Operations
Nike operates primarily in three segments: Footwear, Apparel, and Equipment. Footwear is the company’s main product category, contributing two-thirds of its revenue, while the remaining one-third comes from apparel. In addition to its core brand, Nike also owns popular labels like Jordan and Converse, with Converse accounting for 5% of net revenue as of FY2022.
Lululemon also offers a similar range of products in the apparel and footwear segments; however, apparel is their main revenue contributor.
Both Nike and Lululemon provide customers with an omni-channel shopping experience, allowing them to choose between visiting physical stores or ordering online. Lululemon’s sales strategy is divided between direct-to-consumer sales, accounting for 46% of net revenue, and in-store sales, contributing 45% of net revenue. On the other hand, Nike has a combination of wholesale and direct sales. Wholesale accounts for 58% of net revenue, while direct sales make up the remaining 42%, with half of that coming from digital sales. This means Nike’s direct-to-consumer sales represent approximately 26% of net revenue.
Nike operates worldwide, with major markets in North America, Europe, and China, which collectively generate 75% of the company’s revenue. For Lululemon, the United States and Canada contribute 85% of its net revenue.
Financial summary
According to Nike’s annual report for FY2022, which concluded on May 31, 2022, the company experienced a 6% increase in revenues to $46.7 billion on a currency-neutral basis. This growth was primarily attributed to higher revenue in the EMEA, North America, and APLA regions, partially offset by declines in greater China. The gross margin saw a 120 basis point increase, largely driven by the growth of Nike Direct, the company’s direct-to-consumer business. Seekingalpha.com estimates that the revenue for the most recent quarter, ending in May 2023, should be $50.94 billion, representing a year-over-year growth of 9%.
Lululemon’s latest annual report demonstrates strong performance in FY2022, despite the challenges posed by the COVID-19 pandemic. The company achieved a revenue of $8.1 billion, marking a notable 30% increase compared to fiscal 2021. This revenue growth can be attributed to a 29% increase in comparable sales, a 47% increase in direct-to-consumer sales, and a 21% increase in store sales. Lululemon expanded its global presence by opening 40 net new company-operated stores and witnessing a 41% increase in international revenue. However, the company’s operating margin decreased to 16%.
Fundamentals
Both Nike and Lululemon demonstrate robust financial positions. Nike carries approximately $9 billion in long-term debt, which, considering its strong operating cash flows of $5.2 billion and free cash flow of $4.4 billion, poses minimal financial risk. Additionally, Nike boasts a healthy interest coverage ratio of 32.56. On the other hand, Lululemon has no long-term debt obligations. Both companies have established a consistent track record of profitability, consistently achieving profitability over the past decade.
| Returns and profitability | Nike | Lululemon |
| Gross Margin | 45% | 54% |
| Operating Margin | 13% | 20.5% |
| Return on Invested Capital | 30% | 44% |
Lululemon’s higher gross margin of 54% compared to Nike’s 45% suggests that Lululemon has been more effective in managing its production and supply chain costs, resulting in a higher percentage of revenue retained after accounting for direct costs. Additionally, Lululemon holds a significant advantage over Nike in terms of direct-to-consumer (DTC) sales. DTC sales include all orders made through the company’s website and mobile app. For Lululemon, DTC sales account for 46% of total revenue, whereas Nike generated 26% of its sales through digital channels. In North America, this number rises to approximately 33%. DTC sales benefit Lululemon by eliminating intermediaries, leading to improved overall margins. In an inflationary environment like the current one, Lululemon has more flexibility to absorb higher input costs due to this advantage. This also translates into higher returns on invested capital.
| Growth | Nike | Lululemon |
| Revenue growth | 6% | 15% |
| EPS growth | 12% | 22% |
Lululemon’s significantly higher growth rates in both revenue and EPS suggest that the company has been executing its growth strategies effectively, potentially gaining market share and expanding its customer base.
Near-term financial outlook
Nike has experienced a decline in annual operating margin over the past three years, facing various challenges that have impacted its ability to raise prices and offset labor shortages and supply chain issues. The company has also encountered difficulties in China, including local competition and the repercussions of COVID-related shutdowns. Looking ahead, increased inventory levels will likely require Nike to further reduce prices in order to clear stock, further impacting near-term margins.
In contrast, Lululemon has been enjoying a strong growth trajectory. In FY2019, the company set a goal to double its revenue by 2023 through initiatives such as expanding its men’s revenue, focusing on digital channels, and expanding internationally. Lululemon successfully achieved this goal by 2022. This year, the management has introduced a new five-year plan aimed at doubling revenue through increased emphasis on men’s products, direct-to-consumer sales, and international net revenue. The management’s clear focus and effective execution are evident in the 30% revenue growth reported in the latest annual report, along with stable operating margins.
Valuation
I will be calculating fair value using Discounted Cash Flow (DCF) model and Peter Lynch’s fair value calculation. Summary of fair value from both methods and current stock price given below:
| Nike | Lululemon | |
| DCF fair value | $39 | $152 |
| Peter Lynch’s fair value (avg EBITDA growth rate * next year EPS) | $39 | $159 |
| Current Price | $107 | $340 |
Considering the current stock prices, both Lululemon and Nike are trading at relatively high forward price-to-earnings (PE) ratios. Lululemon’s forward PE stands at approximately 30x, while Nike’s is around 33x. These valuations indicate that investors have priced in expectations of continued growth for both companies. However, it is important to note that sustaining the same level of growth achieved in FY2021 and FY2022 is unlikely.
Looking ahead, it is reasonable to anticipate that Lululemon will maintain a higher revenue growth rate compared to Nike. Detailed projections for revenue and operating income growth rates for both companies can be found in the tables below. These growth estimates provide valuable insights into the expected performance of each company moving forward.
While the rich valuations may be justified to some extent based on their historical growth rates, it is crucial to approach these stocks with caution and consider the potential challenges and uncertainties that lie ahead. Prudent investors should carefully evaluate the growth prospects and valuations of both Lululemon and Nike to make informed decisions in the dynamic athletic apparel market.
DCF – Nike
| 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | Terminal | |
| Revenue | $39,117 | $37,403 | $44,538 | $46,710 | $50,914 | $54,478 | $59,108 | $63,837 | $69,902 | $ 72,698 |
| Revenue Growth | 7% | -4% | 19% | 5% | 9% | 7% | 9% | 8% | 10% | 4% |
| Income from operations | 4,772 | 3,115 | 7,231 | 6,675 | $6,619 | $7,082 | $7,684 | $8,299 | $9,087 | $9,451 |
| Income tax expense | 772.00 | 348.00 | 934.00 | 605.00 | $1,390 | $1,487 | $1,614 | $1,743 | $1,908 | $1,985 |
| Operating Income after Tax | $ 3,869 | $ 2,616 | $ 6,001 | $ 5,771 | $ 4,930 | $ 5,296 | $ 5,771 | $ 6,257 | $ 6,880 | $ 7,466 |
| Re-investment | $ 968 | $1,040 | $ 1,133 | $ 1,229 | $ 1,351 | $ 2,489 | ||||
| FCF to Firm | $ 3,962 | $ 4,256 | $ 4,638 | $ 5,028 | $ 5,529 | $ 4,977 | ||||
| Terminal value | $ 71,105 | |||||||||
| Present Value | $ 3,567 | $ 3,451 | $ 3,387 | $ 3,306 | $ 3,274 | $ 42,103 |
Operating margin – 13%, Tax rate – 21% and Re-investment rate – 20%
Discount rate – 11%
| Present Value of Total CF | $ 59,087.86 |
| Cash, Cash Equivalent, Marketable securities | $ 12,997 |
| Long tern Debt obligations | $ 8,920.00 |
| lease obligation | $ 2,777.00 |
| Equity Value | $ 60,387.86 |
| Total shares outstanding | 1544 |
| Equity value per share | $ 39.11 |
DCF – Lululemon
| 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | Terminal | |
| Revenue | $3,979 | $4,402 | $6,257 | $8,111 | $9,368 | $10,585 | $11,962 | $12,918 | $14,210 | $14,637 |
| Revenue increase % | 21% | 11% | 42% | 30% | 16% | 13% | 13% | 8% | 10% | 3% |
| Income from operations | 889 | 813 | 1,375 | 1,726 | $1,967 | $ 2,223 | $ 2,512 | $ 2,713 | $ 2,984 | $ 3,074 |
| Income tax expense | 251.80 | 230.40 | 358.50 | 477.80 | $ 590 | $ 667 | $ 754 | $ 814 | $ 895 | $ 645 |
| Operating Income after Tax | $ 637 | $ 582 | $1,016 | $1,248 | $1,377 | $ 1,556 | $ 1,758 | $ 1,899 | $ 2,089 | $ 2,428 |
| Re-investment | $ 299 | $ 338 | $ 382 | $ 413 | $ 454 | $607 | ||||
| FCF to Firm | $1,078 | $ 1,218 | $ 1,376 | $ 1,486 | $ 1,635 | $1,821 | ||||
| Terminal value | $22,764 | |||||||||
| Present Value | $ 970 | $ 987 | $ 1,004 | $ 977 | $ 967 | $ 13,473 |
Operating – 21%, Tax rate – 30% and re-investment rate – 22%
Discount rate 11%
| Present Value of Total CF | $ 18,379.19 | |
| Cash, Cash Equivalent, Marketable securities | $ 1,155 | |
| lease obligation | $ 862.00 | |
| Equity Value | $ 18,672.09 | |
| Total shares outstanding | 122.204 | |
| Equity value per share | $ 152.79 |
Final Thoughts
In summary, Nike and Lululemon are well-established athletic apparel brands with distinct strengths and growth prospects in the market. Both companies are focused on expanding their revenues through product diversification, improving the customer experience, and exploring new markets. They have demonstrated their ability to create value for shareholders and customers thus far, and they are expected to continue doing so in the future. However, prospective investors should exercise caution, as both stocks are currently trading at a significant premium compared to their fair values. It would be wise to wait for more favorable pricing before making investment decisions in these companies.
Disclaimer
The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice.