Not So Fancy About Lululemon

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Lululemon (NASDAQ: LULU) experienced a huge price decline of more than 17.5% – to more than $67.80 per share – in only one trading day. The significant drop in its stock price was due to the news that CEO Christine Day would be leaving the company after five and a half years working for Lululemon. Christine Day will still lead the company during the time that Lululemon searches for its new CEO. Should investors be bearish about the unexpected resignation of Day?

Slow growth in first-quarter earnings

In the first quarter 2013, Lululemon experienced year-over-year growth in both its top line and bottom line. Revenue increased from $285.7 million in the first quarter last year to $345.8 million this year while the net income increased by nearly 1.4% to $47.28 million. The low growth in its net income was due to a much higher cost of goods sold and sales, general and administrative expenses. The gross profit margin came in at 49.4%, much lower than the gross profit margin of 55% in the first quarter 2012. The lower gross margin was attributable to a $17.5 million for inventories provision relating to a pants recall. On the constant-dollar basis, its same-store sales growth was around 7%.

Expensively valued

What I like about Lululemon is its conservative capital structure. As of May 2013, it had $930 million in equity, $588.4 million in cash and no debt. The biggest item in its liabilities was accrued liabilities, booked at more than $38 million in May 2012. Looking forward, Lululemon expected to generate around $1.64 to $1.66 billion in revenue, with the diluted EPS staying in the range of $1.96 to $2.01 for the full year 2013.

Lululemon has made moves to expand its footprint internationally. It has recently opened two showrooms in London, and one in Germany and in Singapore. Indeed, Lululemon has a lot of room to expand its business overseas. The market potential is huge, the success will depend a lot on its execution.The market seems to value Lululemon quite expensively, at as high as 22.8 times forward EV/EBITDA.

EV/EBITDA represents Enterprise Value/Earnings Before Interest, Taxes, Depreciation and Amortization. This ratio adjusts the cash and debt position in the company’s market value, and then compares it with the cash flow position of the company. The lower the ratio, the cheaper the stock.

A lot of excitement for Under Armour, but it is also expensive

Compared to its peers, including Under Armour (NYSE: UA) and Gap (NYSE: GPS), Lululemon is the most expensively valued. Under Armour also has a high EV multiple. At $59.60 per share, Under Armour is worth nearly $6.3 billion on the market. The market values Under Armour a bit cheaper than Lululemon, at 19 times its forward EBITDA. Investors might be excited with the bright 2013 outlook of Under Armour. Recently, the company raised its full year outlook after reporting impressive first-quarter earnings results. The revenue was expected to come in at around $2.21 to $2.23 billion while the operating income would stay in the range of $256 million to $258 million, year-over-year growth of 23%-24%. It set the goal to generate $4 billion in revenue and $480 million in operating income by 2016, driven by the transformation of technology and design, category expansion and platform innovation.

Under Armour plans for its huge growth in overseas market. It intends to increase the percentage of revenue from international markets from 6% in 2013 to 12% in 2016. Within the next two years, it will open subsidiaries in different parts of the world including Mexico, Chile, Brazil and Australia. 

Is Gap a better buy?

Among the three companies, Gap is the cheapest valued. It is trading at around $41 per share, with the total market cap of around $19.1 billion. The market values Gap at only 7.2 times its forward EBITDA. Gap has been trying to expand its footprint internationally. Recently, the company announced the new agreements with its existing franchise partners Neutral and Gottex Brands for the Paraguay and Hungary markets, respectively. It also announced that the first freestanding Banana Republic store will be opened at the end of 2013, along with its partner Distribuidora Liverpool. The company reported that in the past six years, it has built more than 300 franchise stores in 40 markets around the world. Looking forward, by the end of 2013, the company set the target to have its presence in eight Latin American countries such as Peru, Colombia, Paraguay, Panama, Brazil and Chile.

Income investors would prefer Gap the most, as it is the only company paying dividends with a yield of 1.4%, while Lululemon and Under Armour do not pay any dividends.

My Foolish take

I would not touch Lululemon now because of the unexpected CEO departure and its substantially high valuation. Gap, with a relatively low valuation and decent dividend yield, seems to be the stock for investors to hold in the long run at its current price. Moreover, the business expansion in the Latin American market would create a lot of upside for the company in the near future.

Lululemon has the potential to grow its sales by 10 times if it can penetrate its other markets like it has in Canada, but the competitive landscape is starting to increase. Can Lululemon fight off larger retailers and ultimately deliver huge profits for savvy investors? The Motley Fool answers these questions and more in its most in-depth Lululemon research available. Thousands have already claimed their own premium ticker coverage; gain instant access to your own by clicking here now.

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Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica and Under Armour. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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