3 Reasons Under Armour Should Buy Lululemon Athletica

By Markets Fool.com

Under Armour has rewarded its shareholders handsomely so far this year, with the stock climbing as much as 20% year to date. However, getting the athletic apparel stock to climb higher from here could prove challenging, particularly because shares are now trading around $81 apiece, or at roughly 88 times earnings. Under Armour also looks expensive given the stock's price-to-earnings growth ratio of 3.80, which is among the highest PEGs in the industry today.

Continue Reading Below

No one doubts Under Armour is doing a lot right these days, including increasing its share of the footwear market thanks to the recent launch of its Curry One basketball shoe and growth overseas. Still, if the sports retailer really wants to gain an edge against its biggest rival,Nike , then it should consider acquiring athletic luxury brand lululemon Athletica , while it still can.

It's in this spirit that I've outlined below three compelling reasons why Under Armour should scoop up Lululemon.

Stretching its women's apparel business
Under Armour has had its eye on the women's apparel business as a key growth area for years now. However, it's only recently started to gain traction in the category. Under Armour's management has been frank about the challenges of women's active wear, noting that instead of simply hawking tight T-shirts in sporting goods stores, women's apparel demands fashion and product diversification.

This isn't because of a lack of hustle on Under Armour's part. The company's women's segment, in fact, has grown into a $600 million business. However, if it ever hopes to catch up to Nike in this category, it needs help from someone who knows women -- cough, Lululemon, cough. This is especially true considering that Nike's women's business is now a mind-blowing $5 billion category for the sports giant. Not to mention, Nike's fast growing women's segment actually grew at a faster clip than its men's business last year.

Lululemon, then, would be a natural fit for Under Armour as it is one of the purest plays in the women's activewear market today. The high-end yoga and sports apparel brand topped Wall Street's expectations for the eighth consecutive quarter when it reported fiscal 2015 first-quarter results on Tuesday. Lululemon's revenue climbed 10% to more than $425 million in the period. Scooping up Lulu might give Under Armour a fighting chance against Nike in the women's activewear market.

Continue Reading Below

Taking stock
Lululemon currently trades at just 26 times next year's earnings, which is significantly more attractive than Under Armour's forward P/E of nearly 60 today. Acquiring the rival athletic brand would not only compliment Under Armour's existing business, it would also help the company create shareholder value by bringing key metrics such as free cash flow and price-to-earnings back into attractive territory. Not to mention, Under Armour's market cap is more than double that of Lululemon. This could make it easier for Under Armour to close a big deal using stock as currency.

Source: Lululemon Athletica.

A more lucrative retail structure
On top of these things, acquiring Lululemon would give Under Armour a foot into the more lucrative company-owned retail structure. You see, Lululemon currently owns its stores, which in turn helps the retailer capture some of the highest margins in the business. By distributing its merchandise through its network of more than 316 corporate-owned stores today, Lululemon keeps more of the profit from sales than Under Armour, which sells its products through retail chains like Dick's Sporting Goods.

Under Armour's traditional business of selling to department stores and fitness big boxes helps it scale faster. However, it also lowers overall margins for Under Armour since the dollars it earns through this model are less valuable than Lulu's direct to consumer model. By acquiring Lululemon's growing network of retail stores, Under Armour could diversify its revenue mix and lift margins in the process.

On the flip side, Lulu has only recently started to gain traction with its men's business. Joining forces with Under Armour would therefore create a better-rounded company in the overall active apparel space. While I like Lululemon as a stand-alone business, I ultimately believe it would be a stronger brand if it were to merge with Under Armour. Similarly, I think Under Armour and its shareholders would benefit greatly from a deal with Lululemon and its loyal female customers.

The article 3 Reasons Under Armour Should Buy Lululemon Athletica originally appeared on Fool.com.

Tamara Rutter owns shares of Lululemon Athletica. The Motley Fool recommends Lululemon Athletica, Nike, and Under Armour. The Motley Fool owns shares of Lululemon Athletica, 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.