Should You Buy Lululemon Athletica Inc. (LULU) Stock? 3 Pros, 3 Cons

Until Wednesday, it had appeared Lululemon Athletica Inc. (NASDAQ:LULU) could overcome the retail sector’s woes. But the company’s fourth-quarter earnings report and forward guidance dashed those hopes, and dashed LULU stock

Should You Buy Lululemon Athletica Inc. (LULU) Stock? 3 Pros, 3 Cons
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At this writing, Lululemon shares are down close to 20%. The company’s quarter came in a bit light, and worse, Lululemon slashed guidance.

LULU has now wiped out all gains since last fall and finds itself back at 52-week lows. The question now is: Is Lululemon a buy here, or is it best to step aside and wait for even lower prices?

LULU Stock Cons

Disappointing Lululemon Earnings: It would be an understatement to say the market didn’t like Lululemon’s latest earnings report. On Wednesday, LULU traded up 4% to $66 … but those gains turned into massive losses in the after-hours session, and they haven’t abated Thursday morning. Shares have collapsed to just $54 in the after-hours session — nearly 20% in declines.

The company’s earnings report wasn’t all bad. EPS missed by a penny, coming in at $1 per share versus expectations of $1.01. But the company showed strong enough revenue growth and put in some good work on the margin expansion front. However, investors are looking to the future, rather than the past quarter’s results. And on that front, Lululemon disappointed. Full-year guidance is poor; management warned of a soft start to the year. And given the troubles for the retail sector, the market has been crushing any store with soft guidance this year.

Changing Fashion Trends: Canaccord Genuity analyst Camilo Lyons wrote the following recently: “The new trends in denim suggest the triangle is turning right side up (tight tops paired with roomy bottoms).” Lyons suggests that jeans will be increasingly popular in 2017 and into next year. That would come at Lululemon’s expense — and for that matter, companies like Nike Inc (NYSE:NKE) and Under Armour Inc (NYSE:UAA), which are both under their own set of pressures.

A Canaccord survey found that 18% of respondents intend to buy fewer LULU pants in the coming year. Additionally, half of customers buy Lululemon yoga pants due to fashion, rather than comfort. This class of customer could abandon the brand fairly quick if fashion trends shift. That’d be bad news for LULU stock.

Investors Losing Patience With LULU Stock: One key problem for Lululemon’s stock is that its shareholder base is losing patience. Coming out of the financial crisis, LULU performed brilliantly, running up from the single digits to $80. Not surprisingly, the company attracted a growth-orientated shareholder base.

However, after hitting $80 in 2012, Lululemon stock has gotten stuck. It hit $80 again in 2013. After a step selloff, it made another push last year, touching $80 for the third time. That marks a triple top — a very negative technical formation.

For growth investors, it’s increasingly difficult to hold a stock that hasn’t made meaningful new highs in five years now. And with the lack of a dividend, there’s no reward for staying patient with the stock. Much of Lululemon’s shareholder base will bail if the tide doesn’t turn soon.

LULU Stock Pros

Strong Brand: Lululemon has one of the strongest niche brands in the marketplace. If you hear the phrase yoga pants, you’re immediately going to think of LULU, not a knock-off competitor. Chip Wilson opened the first Lululemon store in 2000. Fewer than 20 years later, the company now counts more than 400 stores and enjoys a cult-like customer base.

The company’s “brand ambassador” strategy has paid huge dividends. The company scopes out a new city, and hooks up local yoga instructors with gear. This builds buzz as the store opens. The company now partners with more than 1,500 brand ambassadors. Lululemon also has cultivated a devoted employee culture far beyond what you’ll find at most other apparel firms.

Proprietary Products: An oft-repeated complaint with apparel makers is that they lack a moat. If one firm rolls out a hot product, competitors will quickly saturate the market with similar product lines. Yoga clothing isn’t immune to this practice.

However, Lululemon has a stronger competitive position than investors may realize. The company sports dozens of patents on its products, particularly in the fabric department. Lululemon famously sued PVH Corp’s (NYSE:PVH) Calvin Klein in 2012 for infringement. Buzzfeed named LULU the fashion industry’s “biggest patent troll” in 2014. Call it trolling or simply defending their property; Lululemon’s unique approach to its intellectual property is worth watching.

Great Balance Sheet: Even after the plunge on earnings, few people would say that LULU stock is cheap. Yes, the stock did just drop almost 20%. But Lululemon guided 2017 earnings to almost 10% below what the market was expecting, resulting in a much narrower contraction in the company’s forward price-to-earnings ratio. Given the updated stock price and $2.31 midpoint earnings guidance, Lululemon is now trading at around 23 times forward earnings.

That is much more palatable after considering that the company has no debt. In fact, LULU has a net cash position of several hundred million dollars. This gives the company a strong operating position. They can buy back stock, or perhaps initiate a dividend as needed to support the share price. They have broad financial latitude to invest for growth in the business as well if opportunities arrive. The clean balance sheet makes them a more inviting M&A target as well.

Finally, it’s worth considering that Lululemon still manages an impressive 25% return on equity “ROE” despite having no leverage. Anything above 20% makes you a top-notch company if you don’t have debt.

Verdict

Lululemon stock has had a terrible run since it failed to break out from the $80 level last year. However, with momentum investors racing for the exits, the value proposition is getting more interesting. There are real questions as to how well Lululemon can continue to grow. Headwinds are mounting.

Regardless, at the much cheaper post-earnings stock price, there’s a decent case to be made for going long. The pristine balance sheet gives management numerous options for supporting LULU stock.

At the time of this writing, Ian Bezek did not hold a position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.

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Article printed from InvestorPlace Media, https://investorplace.com/2017/03/should-you-buy-lululemon-athletica-inc-lulu-stock-3-pros-3-cons/.

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