Which apparel/footwear company should you invest in?
- We compared companies such as Nike, Adidas, Lululemon, Under Armour and Skechers
- Growth opportunities exist within China, huge potentials for Lululemon and Skechers.
- Considering a DCF valuation in isolation, only Skechers is worth buying.
This post is written by Jim (Jiecheng) Huang
With Under Armour (UAA) releasing their earnings reports, we have decided to take a closer look at their major competitors within the apparel/footwear industry. We will compare companies such as Nike (NKE), Adidas (ADDYY), Lululemon (LULU), Under Armours (UAA, UA) and Skechers (SKX) against each other. Three important aspects will be discussed before selecting a company to invest in; valuation, growth opportunity and shareholders’ friendliness. Based on our analysis, we like Skechers. We also think that Nike and Lululemon, for different reasons, might be interesting investment ideas.
For the past year, Adidas and Skechers have done extremely well, increasing their share price by nearly 40% and 20% respectively. The dramatic increase in share price from Adidas reflects its strong revenue and net income growth from 2016 and first quarter of 2017. While Skechers is moving up from previously being undervalued. Nike has been trading steadily as it should. However, Under Armour and Lululemon have taken huge hits due to poor earnings guidance.
|International sales (2016)|
Apart from Adidas, all other companies rely heavily on revenue generated within the United States. There is no preferred approach regarding where the revenue should come from. But as e-commerce becomes ever more popular, regional restrictions should no longer be a factor that limits revenue.
As discussed in earnings reports by Lululemon, Under Armour and Skechers, the greater China regions have become a major focal point for them regarding international sales. With Lululemon entering into the Chinese market in 2017 through physical retail stores, it is obvious that the greater China region will be a deciding factor regarding growth opportunities. This is slightly different for Nike and Adidas as they’ve already established a strong presence in the Chinese market. Next, I will take a closer look at how popular these companies are.
With Google being restricted in mainland China, we are unable to take advantage of Google trends to determine how popular or how frequently these companies are being searched in China. Instead, we are examining data from Baidu index. Which is provided by Baidu (BIDU), the largest search engine in China, holding 76.05% market share in the search Engines market in China, as of April 2017.
The key terms examined are “Nike”, “Adidas”, “Lululemon”, “Under Armour” and “Skechers”. The Baidu index will provide us with an estimation of how frequently these key terms are being searched, which acts as a proxy as for how popular these brands might be. We’ve also examined these key terms in Chinese and results were similar.
From the above Baidu index, we can see a clear dominating position from Nike and Adidas regarding search volumes from 2001 to 2017, while the other three companies are barely visible. However, this was expected, as Nike and Adidas have entered into the Chinese market much earlier. Being a larger company, they were able to promote their brands better.
Also, we examined the Baidu index of Lululemon, Under Armour and Skechers separately to gain a better perspective of how they are doing in comparison.
As shown in the above graph, Lululemon is steadily increasing in popularity, with a search index level of 850 in comparison to 1000 from Skechers and 1700 from Under Armour. Before 2013, the popularity is relatively similar for Under Armour and Skechers. But Under Armour’s popularity increased dramatically from 2014 onwards, while Skechers has been fairly constant. But in terms of revenue generated in the Chinese market, it is a different story. With an aggressive expansion plan, Under Armour reported triple-digits growth in the Chinese market in 2015 to around $80M revenue, but it is still much lower than the $220M reported by Skechers in 2015. Despite continuing to enjoy positive growth in the Chinese market in 2016, both companies were growing at a much slower rate, especially Under Armour. This pattern actually seems to follow the Baidu index. The explanation behind Under Armour being more popular than Skechers while having lower sale numbers is most likely due to the fact that they have bigger name celebrity endorsing their products, such as Stephen Curry.
Overall, Nike and Adidas are still the dominant players, even in the Chinese market. But in terms of growth, they are relatively saturated. While Under Armour and Skechers continue to grow rapidly in the Chinese market. However, the rate their revenue is growing will continue to slow down. This leaves Lululemon to be an interesting company, despite only entering the Chinese market earlier this year, it has already generated popularity close to a well-known brand like Skechers. With a large number of middle-class consumers willing to spend the extra money on branded clothing, we may soon witness a dramatic increase in revenue from Lululemon’s China regional sales.
Intrinsic values are calculated based on a discounted cash flow model.
|Growth rate for the next 5 years||11.34%||19.06%||12.61%||17.55%||13%|
|Terminal Growth rate||3||3||3||3||3|
|Implied 5-year Growth rate||15.48%||29.82%||20.39%||28.38%||2.02%|
As shown above, we are using EPS as a form of cash flow in the discounted cash flow (DCF) model. We are using the trailing twelve-month (TTM) GAAP EPS. Growth rate for the next 5 years is obtained through Zacks Investment Research. Terminal growth rates for all five companies are assumed to be 3% for the following 15 years, in line with long term GDP growth rate. Discount rate is estimated to be the sum of risk-free rate and market risk premium. The 10-year T-Bill rate is 2% to 3% and Market risk premium is around 5% to 6%, which give us an average discount rate of 8%.
Based on our assumptions, Skechers is the only company offering value, with an intrinsic value of $38.43, it is currently trading at $28.69. This suggests that Skecher is trading at a 25% discount, all other companies are trading above they intrinsic value from our DCF model.
However, the intrinsic value from a DCF model heavily rely its assumptions. Especially the future growth rate of the next few year, in our case, it will the growth rate for the next 5 years, which is known to be extremely difficult to estimate. Hence, we will reverse the DCF model and calculate the implied 5-year growth rate, our assumptions of terminal growth rate and discount rate remain constant. Using Skechers as an example, assuming the market price is correct at $28.69, the market expects Skechers to growth at 2.02% on a yearly basis for the next five years. For Skechers, a 2.02% growth rate per year for the next 5 years can be easily achieved. In fact, over the last 10 years, Skechers has been growing its revenues at a CAGR of 8.6%.
However, expected growth rates may not come to reality for companies like Adidas and Under Armour where the market expects 29.82% and 28.38% growth, respectively. For example, Under Armour, even though it has been very successful in the last 10 years, it only achieved EPS growth of 21%, 23% for the last year. So, assuming a growth of almost 30% looks optimistics
It is obvious that Skechers is the only feasible choice when a DCF model is considered in isolation. Next, we will examine a few other key valuation ratios.
|Companies||Market Cap||EV/EBITDA (2017)||P/E
|Operating margins||Debt/EBITDA (2017)|
Despite being the company with the lowest market capitalization, Skechers continues to be the company with the best valuation. With a P/E (TTM) ratio of 18.61X, it is not only below the industry average of 23.6X, but also the company with the lowest P/E ratio. In addition, EV/EBITDA analysis is also examined to consider the differences in capital structure and removes any effects of noncash expenses on a company’s value. Again, Skechers comes out on top with an EV/EBITDA of 8.33X and a P/B of 2.61X.
It is quite clear that, from a valuation standpoint, Skechers is the clear favorite. But if we examine the operating margins, Lululemon takes the lead at 17.96% while Nike follows closely at 13.82%, the other three companies are all within the 7% to 9% range. The financial leverage ratio of net debt over EBITDA shows that Under Armour is the only company carrying too much debt.
It is understandable that, Skechers, being a small cap stock may not be followed closely by many analysts. While products of Skechers are similar to its stock, it does not receive any sort of hype from neither the media nor the general public. This is very different to the other companies that are being examined. Where the hype from Yeezy (Adidas) and Jordans (Nike) not only promotes the brand, but allows the stock to receive overwhelming optimisms from retail investors.
Lululemon, Under Armour and Skechers have not paid any dividend in the past 10 years. While Nike is currently paying a dividend with a yield of 1.22% and is estimated to pay 1.46% next year (Simply Wall st). Adidas is currently paying a 1.1% and is estimated to rise to 1.52% next year.
|Companies||Last 3 months||Shares||Last 12 months||Shares|
|Nike||16 Purchases||972,756||44 Purchases||2,172,514|
|36 Sales||1,326,761||56 Sales||2,501,883|
|Adidas||0 Purchases||0||0 Purchases||0|
|0 Sales||0||0 Sales||0|
|Lululemon||14 Purchases||126,819||22 Purchases||149,646|
|0 Sales||0||16 Sales||12,468|
|Under Armour||3 Purchases||19,944||10 Purchases||67,471|
|7 Sales||25,865||22 Sales||197,791|
|Skechers||0 Purchases||0||2 Purchases||500,000|
|3 Sales||51,500||15 Sales||313,071|
(Insider transaction information are from MarketWatch)
Under Armour is the only company that may cause some concerns with its large amount of insider sales in the past 12 months, which suggests insiders also agreed on the stock being overvalued. But since share prices already declined dramatically and insider transactions for the past 3 months have been a lot more reasonable. While Lululemon has been a company with active insider purchases and a limited amount of sales. The majority of the purchase is from their Director Murphy Glenn K Jr, 100,000 shares were purchased at $55.5 on 26th and 27th of June. Since the transaction, Lululemon share price has increased by over 11%.
In order to get a better understanding of the managers, we read the latest annual statements for all five companies. Most of the annual reports provided good description of the business for the year and a letter from the CEO in addition to the 10-K form. Even though letters from the CEO are usually quite plain, they show whether the CEOs are being open and honest. Letters form the CEOs of Nike and Adidas provided insightful information that were additional to the material provided10-K form. On the other hand, the Letter from the CEO of Lululemon were quite plain and short. While Under Armour focused heavily on the successful side of the story and did not mention or explain any solution to the decline on their share price, which was nearly halved at the time.
The apparel/footwear industry has experienced tremendous growth in the past few years. In this article, we’ve analysed five companies that, in our opinion, not only target different audiences but also offer a different level of risk and reward. In terms of growth opportunity, Lululemon and Skechers hold the highest upsides, especially due to potential in the Chinese market. Nike and Adidas also continue to grow but at a much slower pace. Valuation wise, out of the five companies, Skechers is the worthiest company to buy at its valuation. Both Nike and Adidas seems very shareholder friendly with the steady dividend and limited insider transaction concern. While managements of Lululemon shows the tremendous confidence, they have in their company.
Overall, we believe that Nike, Lululemon and Skechers are companies worth considering. Lululemon is the company with the highest growth potential at an almost reasonable price but with some uncertainties on the orizon. Nike is a solid company but comes at a hefty price. We own shares in Nike, we won’t sell, but we would not buy at current prices. Skechers is our pick. It offers a good company at a discount to its intrinsic value. We are uncertain on Adidas and Under Armour as the valuations are relatively high, and there is too much uncertainty around growth potentials.
Categories: International Stocks & Other