Lululemon Love Story About to Unravel

Care to guess what stock (with a market cap greater than $2 billion) is the ninth-best performer in the past 52 weeks? I’ll give you a hint: It’s Vancouver-based and caters to the yoga crowd. Yes, it’s none other than Lululemon (NASDAQ:LULU), the hottest retailer anywhere.

Its stock is up 154% in the past year while the S&P 500 is down double-digits. Its supporters swear by its product, and same-store sales numbers suggest this lovefest isn’t going away anytime soon. However, its stock is down 25% in the past month — an unpleasant summer surprise for its shareholders. And I have advice for those shareholders: Hang on. The worst has yet to come.

EV/Enterprise Value

Despite a 25% adjustment in its stock price, its enterprise value still is 25 times EBITDA. Meanwhile, Apple (NASDAQ:AAPL), which appears to have more money than the U.S. government, trades at 10 times EBITDA. This is particularly puzzling because although Apple is a retailer, it also is a significant player in the technology biz — and we know from past experience how ridiculous tech valuations can get.

The fact of the matter is this: Apple is outgrowing Lululemon almost 2-to-1. In their most recent quarterly reports, Apple’s revenue and earnings per share increased 82% and 125%, respectively, while Lululemon’s revenue and EPS grew 35% and 70%. Although we aren’t comparing the same quarters, I think you get the picture. Apple is a steal in comparison.


I didn’t think Gap (NYSE:GPS) could, but it has fully committed to growing its brand, Athleta, most likely to give Lululemon fits in the coming years. Today, it has four stores open; two in San Francisco and two in New York City, with openings in Los Angeles, Washington, D.C., Philadelphia and Minneapolis scheduled for the coming months. By 2013, it expects to have 50 stores open in the U.S., compared to Lululemon’s present 81 and about 10 additions per year from 2011-13 for a grand total of 111. Suddenly, the competition is heating up.

It’s important to remember that Lululemon’s had stores open in the U.S. since 2003. Athleta’s first store opened in 2010. Despite a big head start, Athleta can and will make up the difference before the end of the decade. How do I know this? It’s the only growth brand Gap has available. The rest are tired and receiving oxygen.

Exact revenue numbers for Athleta are difficult to ascertain because they are part of “other” revenue and include segments like Piperlime and its wholesale business. However, I’d guess about 80% of the $246 million in 2010 revenue is attributable to Athleta. I base this estimate on the fact Gap paid $150 million in 2008 to buy the lifestyle brand, which is about 0.76 times forward sales.

The important thing to remember is most of Athleta’s revenue thus far is from e-commerce. It already has done the difficult part. Lululemon, on the other hand, has blown up its e-commerce model and is virtually starting from scratch. There’s no certainty its customers will be as loyal online as they’ve been off. In the end, e-commerce is going to make or break Lululemon.

Potential Upside

Ben Graham had a simple formula he used to determine if a stock is worth a look. He believed a good stock is one where the P/E and price-to-book value are no more than 15 and 1.5, respectively, and multiplied together, total no more than 22.5. Of course, he was a value investor, so Lululemon doesn’t really apply.

However, some bright people realized that if you multiplied 22.5 by earnings per share and book value per share, then calculated the square root of the total, you’d have a general idea about the potential upside. Using Lululemon’s trailing 12-month EPS of 94 cents and a book value of $3.60, I get a fair-value estimate of $8.72. That’s quite a bit lower than its current price of $46.

At this point, I can hear shareholders screaming in outrage, so let me do you a favor. I’ll double each of those numbers to $1.88 and $7.20. It’s still only $17.46, and let me be clear: The 2013 analyst estimate of $1.36 per share assumes there will be very little competition for the retail darling. That assumption is 100% wrong. If Gap messes up its golden opportunity, which is still very possible, Nike (NYSE:NKE) or Under Armour (NYSE:UA) are capable of taking up the gauntlet.

Bottom Line

With the likelihood of a double dip on both sides of the border very real, I’d sell now while you still have something to show for it.

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