Shopping list

Lululemon should be on your shopping list

  • Lululemon’s second quarter earnings were surprising in the current retail environment
  • The second quarter should reassure investors worried about the company’s evolution in the face of inflationary and recessionary risks
  • The valuation is high, but like its products, LULU is worth it

It’s worth putting into context just how impressive Lululemon Athletica’s (NASDAQ:) second quarter earnings were.

Yes, the company smashed analyst estimates in the , and gave a full-year outlook above the Wall Street consensus. But that’s not the most important aspect of the release.

What’s impressive is the performance relative not to expectations, but to the rest of the apparel industry, and indeed to retail as a whole. Lululemon is booming while just about everyone else is struggling.

Thanks in part to a post-earnings rally, LULU is admittedly not cheap. But the stock hasn’t been cheap for years, but it has been one of the best performers of the past decade. When it comes to large cap names, there is a case where it will be the same over the next 10 years as well.

Source: Investing.com

Clothing retailers struggle

In 2021, consumers were buying things, including clothes. Even struggling mall retailers posted strong revenue growth. Above all, they did so without the discounts and promotions that had marked the pre-pandemic environment. As a result, operating margins have soared.

In contrast, 2022 was a completely different story. With the return to normal, spending on travel and experiences has returned. Labor Day air traffic in the United States exceeded pre-pandemic levels. With so many new things cluttering the closets, there’s simply a lot less need for new clothes.

As a result, comparable store sales fell across the industry. Even the biggest and best retailers like Walmart (NYSE:) and Target (NYSE:) managed billions of dollars in excess inventory. Small specialty retailers have seen their profits – and, in most cases, their stock prices – return to 2010 levels.

Add to that inflationary pressures and the retail environment is as challenging as it has been since the financial crisis, at least.

Lululemon still thrives

But none of those headwinds were apparent at all in Lululemon’s second quarter. Same-store revenue grew 23%, even with a two-percentage-point success of the strongest. Adjusted operating margins increased slightly.

In the release, Lululemon offered comparisons to the second quarter of fiscal 2019. Over that three-year period, revenue more than doubled. Gross margin increased and adjusted earnings per share increased by 135%. Inventory rose sharply, but management insisted inventory was adequate for expected second-half sales.

In any environment, this type of growth would be impressive. In this environment, it’s amazing.

Is performance charged?

Commercially, it is difficult to find a care. This is a quality company that has clearly struck a chord with consumers around the world. (About a third of sales so far this year come from outside the United States) Operating margins of over 20% are among the highest in the industry, showing that consumers are willing to pay for Lululemon quality.

The competition is far in the distance. Gap Inc. (NYSE:) has its Athleta nameplate, but its sales and margins are well below those of Lululemon.

The only real question is the stock price.

Based on guidance, which is generally conservative, Lululemon should generate around $10 of adjusted earnings per share. This implies a price/earnings multiple of 34x.

In the current growth environment, this multiple does not seem so expensive. For the full year, EPS is expected to grow around 28% year-over-year.

But clothing customers can be fickle. All it takes is one fashion faux pas to slash sales and squeeze margins. A gradual return to the office could boost business-casual options at the expense of Lululemon’s “athleisure” offering. Even Wall Street doesn’t seem so enthusiastic: the average price target of $381 only suggests an upside of around 11% over the next 12 months, and analysts are generally overly optimistic.

Certainly, a market-driven sell would create a more attractive price and a more attractive bullish case. But even here, it’s hard to argue too strongly against the stock. Long-term performance and dominance over competitors suggest Lululemon has years of growth ahead of it. The strong performance of men’s clothing expands the company’s market.

The clear comparison at this point is Nike (NYSE:), another stock that historically has looked overpriced. Even with a steep pullback, NKE was one of the best stocks of the century, gaining over 1,600%.

Lululemon has similar potential: to both dominate and expand its category, while maintaining impressive profit margins. Lululemon currently has a market capitalization of $43 billion; Nike’s is almost four times higher.

And so as long as Lululemon continues to operate like this, LULU stock can continue to rally.

Disclaimer: At the time of this writing, Vince Martin has no position on the titles mentioned.