Just Breathe and Buy More
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
High-end clothing companies have certainly been popular investments over the last few years. The two primary competitors in the space are Under Armour (NYSE: UA) and Lululemon (NASDAQ: LULU). While fans of Nike (NYSE: NKE) certainly have nothing to be ashamed of, these two upstarts have clearly stolen the spotlight from their larger and more established competitor. While there's no question that neither Lululemon or Under Armour are what anyone would call cheap, in my opinion Lululemon represents the best value of these three companies.
In the high-end apparel industry when people think of yoga, more and more they think of Lululemon. Given the fact that historically women have spent much more on clothing than men, this positions Lululemon to continue to grow quickly. While it's true that Under Armour is beginning to target this market as well, Lululemon has a vast lead and their connections to yoga instructors should continue to serve the company well. What's fascinating to me is, the number of times that short-term thinking leads to concerns about a company's operations, where there really is no issue. In fact, Rich Duprey of The Mötley Fool penned an article back in June, that outlined some of the worries that short-term investors had about Lululemon.
Just a few months ago, Lululemon released guidance that suggested earnings-per-share for the current quarter could come in at about $.30 per share. This was a concern because the prior consensus estimates were between $.28 and $.33 for the current quarter. There were two reasons given for the possibility of the slightly lower guidance. Either the company was lowballing EPS, or inventory concerns would cause the company to mark down product, which would hurt profits. In this space inventory concerns have been an issue, as analysts many times cite Under Armour and their high level of inventory. It turned out that Lululemon's earnings per-share came in at $.34 with adjustments for some one-time tax issues at the company. These results were good enough for yet another earnings beat, which has been consistent in the history of the company. Let's take a look at the details of Lululemon's earnings to get a sense of the strength of this company.
In the most recent quarter, revenue growth was 33%, driven by comparable sales up 15%. This strong revenue growth generated a 50% increase in diluted EPS, and one of the most impressive figures was the jump of 91% in direct to consumer sales. The fact that Lululemon only operates 189 stores should give investors hope that the company's huge growth rate should continue. What was equally impressive, was Lululemon's financial statements which showed improvements in nearly every measure. The company's cash and cash equivalents jumped almost 68% year-over-year, and operating cash flow was up over 225%. One slight issue that investors should keep their eye on, was the gross margin declined from 57.5% last year to 55.1% this year. When it comes to the concern of inventory levels, let's put this issue to rest once and for all.
In my eyes, the best way to manage inventory comparisons is relative to sales. It makes sense that as a company grows it's going to have to keep more inventory on hand. That being said, the concern that Lululemon is keeping too much inventory just doesn't hold water. In the last three years, the company's inventory relative to their annual sales was at most 10.41%. By point of comparison, Under Armour showed an inventory to sales level of more than double Lululemon last year. In fact, even Nike carried between 10.7% and almost 14% as an inventory to sales level during this same timeframe. When a well respected apparel retailer like Nike, is carrying more inventory on a relative basis than a start up like Lululemon, saying that inventory is a concern doesn't make sense. Now that we can see that inventory should not be a concern for investors, what can we expect from Lululemon in the future?
With just two quarters left this year, the company's guidance for the full year is all that really matters. Lululemon sees earnings-per-share coming in between $1.76 and $1.81, which is right in line with analyst estimates. This would represent earnings-per-share growth of about 40% as a worst case scenario. Lululemon consistently beats estimates, so the number is likely to come in higher. While there's no question the shares are not cheap at over 40 times this year's earnings expectations, the price becomes more reasonable looking at next year's earnings. Based on 2013 estimates, the shares trade for about 34.5 times next years EPS. With greater than 23% revenue growth expected next year, analyst expect longer-term EPS growth of better than 27%. Relative to Under Armour, the company has a higher expected growth rate and a lower P/E ratio in both years. While I'm sure some investors would suggest that Nike represents a better deal, the numbers don't bare this out. Nike sells for more than double its forward growth rate, and the company's expected revenue growth is less than one third Lululemon's. For investors looking for fast growth and well-run high-end apparel retailer, there isn't a better option than Lululemon in my opinion. While the valuation might scare away some investors, like in yoga I would say just breathe.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Lululemon Athletica and Under Armour. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.