3 Reasons Lululemon Athletica Inc. Will Stall Out

LULU stock - 3 Reasons Lululemon Athletica Inc. Will Stall Out

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Lululemon Athletica inc. (NASDAQ:LULU) has had a big run. On June 1, the Lululemon stock price hit a 17-month low heading into first-quarter earnings. Since then, however, LULU stock has gone almost straight up, gaining 57% and touching its highest levels in 15 months.

There’s reason for optimism. I didn’t think Q1 earnings were spectacular — but they were a step in the right direction. Q2 was solid, and Lululemon posted another beat last week. The retail space as a whole looks much stronger, and fears of an “athleisure bubble” have receded.

Indeed, everything seems like it’s going right for Lululemon. But that’s one of the risks facing LULU stock at the moment, and one reason why I’d suggest investors head to the sidelines after the big gains in the Lululemon stock price.

We’ve Been Here Before With LULU Stock

This isn’t the first time it’s looked like the Lululemon stock price finally has turned the corner. LULU cleared $80 — roughly 7% above current levels — in 2012, 2013 and 2016. Each time, the stock pulled back quickly.

This stock has been range-bound for over five years now. It’s seen sentiment swing rather sharply. Optimism toward the company’s long-term growth profile is offset by concerns about trends and competition from rivals like Gap Inc (NYSE:GPS) unit Athleta.

I’m not sure 2017 results imply that those concerns are quieted.

According to the Lululemon quarterly report, year-to-date, total comparable sales, including direct to consumer (DTC), have risen 5%. The figure was the same for full-year 2016 in constant currency. 2015 comps were up 10% excluding dollar moves, and up 5% as reported.

Pretty much all of that growth is coming from the DTC business. So far this year, in-store sales have increased just 1%. DTC sales are up 18%, with a four-point bump from online “warehouse sales” held in Q2.

DTC growth and strong performance on margins have driven much of the optimism toward Lululemon stock so far this year. The company isn’t getting caught in the retail trap of seeing growth decelerate, and margins have risen nicely this year, showing that the brand is strong enough to avoid the promotional pressure seen elsewhere.

Both trends are important, and there is good reason for the recent gains. But over time — going back years — Lululemon hasn’t been able to consistently show that kind of performance. Anyone buying LULU stock at these levels is making a bet that this time is different.

The Retail Rally

The Lululemon stock price is no doubt benefiting from some of the optimism toward retail as a whole. The sector has been the worst performer over the past few years, but has seen a nice rally of late. Class A shopping mall owners like Macerich Co (NYSE:MAC) and Simon Property Group Inc (NYSE:SPG) have bounced. Gap stock recently hit a 2-year high. Abercrombie & Fitch Co. (NYSE:ANF) has almost doubled just since August.

But as I wrote last month when advising extreme caution on ANF, I’m skeptical the sector rally has real legs. The narrative now is one of relief that Amazon.com, Inc. (NASDAQ:AMZN) isn’t actually taking over the retail world. But that’s not the real story. The real story is that aggressive promotional efforts — driven in part by lower mall traffic and in part by online competition — are hurting margins. So are the duplicative costs of running both in-store and online operations.

For companies that generally have operating margins in the low teens at best, a few hundred basis points here and there add up to huge — and permanent — declines in earnings. Because of Lululemon’s higher price point and brand value, it has better margins than most other retailers. But it’s not immune to those pressures.

In 2012, Lululemon’s operating margin was 28.7%. The figure this year will be about 1000 basis points lower. Some of that pressure is coming from store expansion and smaller markets. But it’s too optimistic to suggest that Lululemon is that different from the rest of retail. It’s better — but still subject to the same challenges. If the retail rally fizzles, it likely will undercut some of the optimism driving LULU stock at the moment.

The Lululemon Stock Price

Lululemon is a great brand. It has a solid core of committed customers. It makes great products. But that’s not always the same as a great stock.

Lululemon now has a market capitalization of about $10 billion. The Lululemon stock price sits at 28.2x the midpoint of 2017 earnings per share guidance — even backing out the company’s nearly $5 per share in net cash. LULU is pricing in real growth, for several years.

But I’m far from convinced that growth is coming. 2017 results have been impressive. But for most of this decade, LULU stock has priced in that type of growth and then some. And it hasn’t worked out well for many of its shareholders.

The risks that have popped up over the past few years still remain. Investors simply are ignoring them for the time being. When that turns, and I believe it will, it seems likely that, once again, the rally in LULU stock will stall out.

As of this writing, Vince Martin has no positions in any securities mentioned.

Article printed from InvestorPlace Media, https://investorplace.com/2017/12/lululemon-stock-price-reasons-sell/.

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