Rally in Lululemon Athletica Inc. Stock May Be Nearing a Top

LULU stock looks maxed out as it closes in on $80

By Luke Lango, InvestorPlace Contributor

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The awful truth about Lululemon Athletica Inc. (NASDAQ:LULU) stock is that this isn’t a name you want to buy now and hold onto for the long run.

It isn’t a Nike Inc (NYSE:NKE), which is up 160% over the past five years and has headed higher in linear fashion. Nor is it an adidas AG (ADR) (OTCMKTS:ADDYY), which is up 130% over the past five years and has tracked higher in similar linear fashion.

Instead, LULU is a stock that has had its ceiling capped time and time again by an overly aggressive valuation. That is why despite some big rallies over the past five years, LULU stock has gained a total of just 1% in that time frame.

Let that sink in. The S&P 500 is up nearly 90% over the past five years, according to YCharts.

What is happening under the hood?

Everyone got excited about the huge Lululemon trend that dominated athletic retail from 2010 to 2012. Investors bought up LULU stock during that era on expectations for a Lululemon takeover of athletic retail. Those expectations proved to be unrealistically high, and LULU stock has headed sideways ever since. It hasn’t dropped because the numbers are still good. But the stock hasn’t roared higher like its peers because the valuation simply doesn’t support prices above $80 at this point in time.

Consequently, LULU stock isn’t a “buy now, hold forever” type of stock. It’s a “buy-the-dip, sell-the-rally” type of stock.

Right now, it looks like LULU stock is approaching a “sell-the-rally” point. Here’s why.

LULU Stock History Is Flashing Warning Signs

LULU stock has had a big run-up recently. It’s gone from below $50 in May 2017 to nearly $80 today. That is essentially a 60% rally in a few months.

But this rally is nothing new. LULU stock has rallied like this before. And each time, the big rally ended in a big sell-off.

From July 2014 to February 2015, LULU stock rallied from under $40 to nearly $70, a rally of about 75% in just a few months. In February 2015, the stock’s relative strength index (RSI) hit over-bought territory (above 70). The trailing earnings multiple also shot above 37.5x.

LULU stock proceeded to sell off in a big way over the next several months.

From November 2015 to July 2016, LULU stock rallied from under $50 to nearly $80, a rally of about 60% in just a few months. In July 2016, the stock’s RSI again hit over-bought territory. The trailing earnings multiple also shot above 37.5x for the first time since February 2015.

Again, LULU stock proceeded to sell off in a big way over the next several months.

LULU stock finds itself in a similar situation today. It’s up 60% over the past the several months. The RSI is in over-bought territory. The trailing earnings multiple is above 37.5x for the first time since July 2016.

History is flashing warning signs here, and I think investors should pay attention.

LULU Stock Valuation Doesn’t Support Much Higher Prices

The bigger problem here is that fundamentals don’t support a higher LULU stock price at this point in time.

Revenue growth is good and steady, but it’s not getting any bigger. This is a 10% revenue growth story going forward, supported by mid single-digit comparable sales growth and unit expansion.

Gross margins are rebounding, but given increasing material complexity, management doesn’t expect gross margins to get back to their mid-50s peak from a few years ago. Gross margins are running around 52% right now, so that implies maybe another 100-200 basis points of expansion (at best) over the next several years.

 

Double-digit revenue growth should drive some operating expense leverage, but not a ton. LULU still needs to invest to support a growing store base. Consequently, there is maybe about 100 basis points of operating expense leverage potential over the next several years.

Roughly 10% revenue growth, 100-200 basis points of gross margin expansion, 100 basis points of opex leverage, and buybacks should drive around 15% earnings growth over the next several years. (The Street is modeling for 14% growth). But LULU stock is trading at more than a 100% premium to those growth prospects — 31x this year’s earnings.

By comparison, Nike is trading at 27.5x this year’s earnings for 16% earnings growth prospects (about 70% premium to growth.) Adidas is trading at 26x this year’s earnings for 19% earnings growth prospects (about 35% premium to growth). The S&P 500 is trading at 20.5x this year’s earnings for 10.5% growth prospects (about 95% premium).

Bottom Line on LULU Stock

LULU stock is on the heels of a large, multi-month run-up which has plunged the stock into overbought and overvalued territory.

The top may be near.

As of this writing, Luke Lango was long NKE.


Article printed from InvestorPlace Media, https://investorplace.com/2017/12/rally-lululemon-athletica-inc-lulu-stock-may-nearing-top/.

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