Lululemon Athletica Inc. (LULU) Stock Will Stay Stuck in Its Comfort Zone

Well, athleisure isn’t dead after all. Lululemon Athletica Inc. (NASDAQ:LULU) reported blowout second quarter results on Thursday which easily breezed past analyst estimates. Revenues came in higher than expected. So did earnings. Comparable sales growth exceeded expectations. The full-year revenue guide came in above expectations. So did the earnings guide.

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It was a clean beat-and-raise quarter.

And it comes amid murmurs that the athleisure trend is fading.

Athletic apparel retailers like Dicks Sporting Goods Inc (NYSE:DKS), Big 5 Sporting Goods Corporation (NASDAQ:BGFV), Foot Locker, Inc. (NYSE:FL) and Finish Line Inc (NASDAQ:FINL) all reported horrible numbers for this quarter while providing weak guides for the balance of the year. The ugly results had investors concerned that the athleisure trend had peaked, and was now on the retreat.

But the market misread this one. There is just a seismic shift in athletic retail right now from wholesale to direct (read more about it here).

LULU sells entirely direct. You can’t buy a pair of Lululemon leggings anywhere but inside a Lululemon store or through the company’s website. Naturally, this direct-selling strategy is benefiting the athletic apparel brand amid this seismic shift in athletic retail.

So Lululemon stock is up some 8% on the news, back to the area of its mid-August high.

But should you stick with this rally?

I don’t think so. Here’s why.

Lululemon’s Growth Story Isn’t THAT Good

Lululemon’s growth story is attractive, but it really isn’t THAT good. It certainly feels like this brand is over the hump in terms of its heyday, and that growth from here will simply be moderate.

LULU burst onto the athletic apparel scene as the trendy, premium activewear choice for young women. The brand was super popular. Comps were on fire. LULU stock roared higher.

But that growth has slowed, and LULU stock has stalled. The stock has really just been range-bound for the past five years.

Granted, the company does have growth opportunities with men’s apparel and in international markets. There is visibility to $4 billion in revenues by 2020.

But you can’t ignore the fact that comparable store sales rose just 2% last quarter. They fell 1% in the first quarter, and were up 5% last year.

Those aren’t big numbers. Comp growth is clearly slowing. And it’s slowing to a point where it will be tough for management to leverage in-store expenses. Low-single-digit comp growth doesn’t exactly give LULU much wiggle room to grow operating margins.

So investors shouldn’t be surprised when they see that operating margins compressed in the quarter despite gross margin expansion. Management is investing to grow, but those investments are yielding tepid comp growth.

The net result is moderate topline growth and flattish earnings growth. So, right now, the LULU growth narrative really isn’t all the promising.

Bottom Line on LULU Stock

Even if management manages to leverage operating expenses and grow operating margins, tepid topline growth implies a rather moderate earnings growth outlook. The Street thinks Lululemon can grow earnings around 11% per year over the next five years.

But LULU stock isn’t priced for moderate growth. After today’s 8% pop, it trades at nearly 26 times guided fiscal 2017 earnings. A 26 times price-to-earnings multiple for 11% growth seems rich.

Too rich.

Consider this. The S&P 500 is only trading roughly 17 times fiscal 2017 earnings estimates for roughly 11% earnings growth over the next several years.

So the S&P 500 and LULU have similar earnings growth trajectories over the next several years, but LULU stock is trading at a sizeable premium to the S&P 500.

That doesn’t make much sense.

Because of this rich valuation, LULU stock will likely remain range bound into the foreseeable future. So you may as well sell it now, take profits, and wait for the next dip.

As of this writing, Luke Lango was long FL stock. 

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