Appealing Brand but Await a Better Entry Point
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Lululemon Athletica Inc (NASDAQ: LULU) is one of the fastest growing retailers in the industry. The company primarily targets wealthy, athletic women with unique and innovative products. With the growth of yoga industry and increase in the number of women participating in sports and other fitness activities, the company has seen tremendous growth over the past decade. But things haven’t been absolutely perfect for the company this year.
Lululemon’s founder, Chip Wilson, created a lot of controversies about his weird beliefs and had to step aside in January. Moreover, one of its bright neon colours (Paris Pink) also sparked a controversy due to bleeding issues. However, the company continues to post good results and reported Q2 EPS well above the consensus estimates and looks unfazed by the increasing competition from Gap’s (NYSE: GPS) Athleta and Nordstrom’s (NYSE: JWN) Zella. Although, Gap’s Athleta-line and Nordstrom’s Zella both provide cheaper alternatives, they lack the strong brand loyalty enjoyed by Lululemon. I believe the long-term growth thesis remains intact as the recent sales momentum coupled with the company's expansion plans present a long term investment opportunity. But, I suggest investors to await a pullback as the company’s high valuation (forward PE= 37.45) remains a concern and leaves minimal room for errors or hiccups during this period of high growth.
Long-term Growth Thesis Intact
After inter-quarter share price volatility and concerns around product issues, increasing competition and same store sales deceleration, 2Q revealed the core business is in good shape. I believe the company will be able to maintain its leading position in the core yoga market. Longer-term, I expect rapid top-line growth to continue driven by top-notch merchandising, strong e-commerce, robust unit expansion and the fast growing yoga industry.
- Fast Growing Yoga Industry
According to SGMA Participation Topline Reports, yoga participation has grown from 7 million to 22 million from 2000 to 2010, representing a 12% compounded annually growth rate. Interestingly, over the same period running has grown at a lower rate (~5% CAGR) and football has actually declined (-2% CAGR). With growing yoga participation, consumer’s inclination towards active and healthy lifestyle related products/brands is also increasing.
- Unit Expansion Opportunity
After slowing unit growth in 2009-2010 (to 10% CAGR as compared to 54% CAGR from 2004-2008), the company is planning a +20% unit growth in 2012 on top of 27% in 2011. The company has just ~150 Lululemon North America stores in 2011, thus there is a huge scope for increased penetration in the region and I see robust long-term unit expansion opportunity for the company.
- Strong Ecommerce
The strength of the company’s Direct-to-Customer business can be estimated by the 91% growth it posted this quarter. Had e-commerce been included in the same store sales calculations as a store, same store sales growth would have been 23% on a constant currency basis. The Australian website has received a great response from consumers and the company will also be launching country-specific Ecommerce sites for UK and Hong Kong later this year. Thus, I expect Direct-to-Customer business to drive long-term growth.
Lofty Valuation and Constrained Near-Term Growth
Lululemon ended Q2 on a strong note with July being the strongest month in the quarter. The management team indicated that August sales were “quite strong” and provided 3Q same store sales guidance of low to mid teens. However, management also indicated that October same store sales may fall off. Over the balance of the year, I expect same store sales to moderate as the company continues to push innovation instead of rapidly chasing inventories. Moreover, I expect continued margin deterioration in the second half due to ongoing merchandise margin normalization and investment in the product.
Though the company has better growth prospects as compared to Nordstrom and Gap, but it also comes at a significantly higher price. Lululemon is trading at more than 150% premium to both Nordstrom and Gap. Thus, it becomes very risky to buy this stock at such a high valuation.
To conclude, I remain confident in management’s focus on long-term growth through innovation and thoughtful international expansion. Further, I believe Lululemon is an under-penetrated concept early in its growth stage and thus, offers huge potential for same store sales growth as well as unit expansion. Going into FY13, I see a potential EPS upside as the ongoing incremental investments will drive better margins. However, I think there is limited potential upside to the stock as the stock has already soared up over 36% since August and is trading near its all-time highs. I would suggest investors to be patient and await a suitable entry point before buying this stock.
AnjaliPaliwal has no positions in the stocks mentioned above. The Motley Fool owns shares of Lululemon Athletica. Motley Fool newsletter services recommend Lululemon Athletica. 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.If you have questions about this post or the Fool’s blog network, click here for information.