Can Lululemon Athletica Go Back to $80 Per Share?

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

Just a few weeks ago, Lululemon Athletica (NASDAQ: LULU) was trading for $83 per share. Since then, the stock’s price plunged down to $61 and it is currently on its way back up to $67. It looks like the investors are done with worrying about the departure of the CEO Christine Day. During her reign, the company was able to increase its earnings by 300% and many people believed that the company’s growth would slow down or come to a complete halt after her departure.

The company enjoys strong margins, a high growth rate and a healthy balance sheet. When a company has all of these three things going on for it, the investors tend to be very happy. This didn’t happen with the investors of this company as they started a sell-off as soon as Christine Day announced that she was going to leave her position. As the next few quarters pass by, we will find out how much impact she actually had on the company’s growth; however, investors are already assuming the worst.

If the company keeps growing like it’s been growing and if the balance sheet continues to be healthy as it is right now, there is no reason why the share price shouldn’t go back to $80 per share like it was just a few weeks ago. This may take a few quarters to play out, but investing is supposed to be long term after all, so it’s no big deal.

Currently the company has $588 million in cash and no debt. Excluding cash, the company is trading at 33 times its trailing earnings. The company is expected to earn $2.00 per share this year, $2.57 per share next year and $3.09 per share in the following year. Basically, the company is looking at forward P/E ratios of 31, 25 and 20 excluding cash. Keep in mind that the company’s cash balance will be even better than it is today if it can at least meet these expectations, so it may be actually looking at a lower forward P/E excluding cash.

Considering that this is a rapid growth company, it should trade for a higher valuation. In comparison, Nike (NYSE: NKE) trades for a P/E ratio of 25 even though its growth rate is much slower than that of Lululemon. In the last 3 years, Nike’s revenue grew from $19.17 billion to $24.12 billion. This represents a growth of 26% for 3 years. In comparison, Lululemon’s revenue grew from $452 million to $1.47 billion during the same period, representing a growth of 225%. The company’s growth rate is expected to be in the double-digits for the foreseeable future. Don’t get me wrong, Nike is a great investment too; however, Lululemon is being punished unnecessarily right now. N

ike is expected to earn $3.02 this year, followed by $3.42 next year and $3.84 in the year after. This effectively gives Nike P/E ratios of 20, 18 and 16 for the next 3 years. The company currently enjoys healthy margins and a decent growth rate. Nike expects most growth to come from Asia and the Middle East in this decade where the company's products are increasingly popular but too expensive for much of the population. As the economies of these nations improve, Nike's sales should improve accordingly. Keep in mind that Nike's growth rate will be slower than Lululemon's as I've already mentioned. 

Under Armour (NYSE: UA) is another company that competes with Lululemon. This is another company that grows at a rapid rate. The company was able to grow its annual earnings from $0.46 per share in 2009 to $1.21 per share in 2012. This company has a higher P/E than Lululemon at 50, but its P/E is expected to drop to 41 next year, 32 in the following year and 26 by 2015 if its growth rate continues on.

Unlike Lululemon, this company has some debt in its balance sheet but it is minimal (i.e., around $60 million) compared to the company's market value of $6.31 billion. Given the two companies' current valuation, we can see that the market expects Under Armour to outperform Lululemon by a large margin because it is given a much bigger valuation than Lululemon. If the company actually accomplishes what the market expects it to accomplish, there can be a lot of upside for the company. For now, much of the upside is already priced in though. 

Of course, there are some skeptics regarding Lululemon’s future growth prospects. Some people believe that the company’s growth has to slow down because it conducts business in a very specific market with very specific products. Because the company’s products are not broad enough and the prices of these products tend to be on the higher-end, its growth outside of North America is usually questioned.

On the other hand, the company’s past successes should tell us that it can accomplish things in the future as well. Past behavior is the best predictor of the future behavior. Besides, as the company adds more male products to its portfolio and opens stores that sell men products only (scheduled for 2016), its addressable market will grow by 100% as it will include both genders.

A couple months ago, the company had to recall some products due to certain defects but this is now behind the company. I'm sure many lessons were learned in the process and the mistakes will not be repeated. The products of Lululemon are not too complex to build and there isn't that much room for error.  

If the company reports strong earnings in the next quarter (like it did last quarter), the stock price can easily jump back to where it was last month. There is always a risk with smaller companies, but risk is usually associated with returns in the investment world. 

Jacob Steinberg has no position in any stocks mentioned. The Motley Fool recommends Lululemon Athletica and Nike. The Motley Fool owns shares of Nike. 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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