Lululemon Athletica inc. (NASDAQ:LULU) is back in shape. It had a rough couple of years, including product recalls and its infamous see-through pants problem. However, management has righted the ship. LULU stock is back near all-time highs, quarterly earnings results are solid, and the company is targeting big expansion plans overseas.
Is this finally the moment for Lululemon stock to start working out for shareholders again? Or will the company’s lingering issues send it tumbling? Here are the pros and cons for LULU stock heading into 2018.
LULU Stock Cons
Not a Cheap Stock: Lululemon is back to a premium valuation, no matter how you slice it. The company is trading at 38x trailing and 27x forward earnings. That’s not anywhere near the industry median for apparel.
The company is at a steep 4x price/sales ratio. And you had better believe in the company’s brand, because there are few other hard assets here. The company trades at more than 7x book value.
That’s all fine and well if Lululemon is able to grow for many years to come. However, if it’s just the first mover on an increasingly crowded fashion trend, those valuation ratios will not hold up over time. Competitors such as Nike Inc (NYSE:NKE) remain dangerous as well.
Is Athleisure a Fad? A long-running point of debate for LULU stock is whether the company’s products are a fad or the marker of a new persistent trend. Both sides make fair points. And to be honest, it could probably still go either way.
That said, Lululemon’s proponents will note that the company has continued its growth well past where initial doubters thought it’d reach. There’s no sign that yoga, as a trend, is dying off either. LULU stock bears, on the other hand, will point to Lululemon’s struggling Canadian sales.
Remember that the company is originally from Vancouver. It developed its brand and market share there first. So it is somewhat troubling that Canadian sales volume is down three years in a row, and by meaningful amounts.
That said, the Canadian economy isn’t performing that well right now, and besides, Canada is only 20% of Lululemon’s business today. Still, declining Canadian sales do suggest that the company will reach saturation on athleisure at some point.
Key Technical Resistance Level: LULU stock has had a bad history with the $80/share level. The stock originally hit the $80 level back in 2012 during its first big growth phase. Shares consolidated and then made another push for $80 in 2013. LULU stock did nothing until 2016, when it again rallied sharply, hit $80, and then went south.
After dropping below $50 earlier this year, investors have given LULU one more chance. Shares are almost back up to the pivotal $80 mark as we await all-important holiday sales figures.
Needless to say, anything less than great numbers, and LULU is going to get turned back yet again at this key overhead level. On the plus side, should Lululemon hit it out of the park for Q4, you’d likely see a large technical move up to the $90 area as traders buy the breakout over five-year resistance.
LULU Stock Pros
Making New Markets: The bulls have a decent retort for the “athleisure is tapped out” argument above. It’s that Lululemon is successfully stretching into new markets beyond just western women.
For one, we’re seeing the rise of male athleisure clothing. Lululemon is up to 18% of its customers being men, and the company sees this moving toward a quarter of its customers within the next few years. It’s unlikely Lululemon will ever be a company whose stores are full of men, but even a modest presence in male athletic apparel can move the needle.
On top of that, Lululemon is largely going abroad for future growth, with initiatives such as “Unroll China.” This year’s Unroll China event had expected participation of 10,000 people across six Chinese cities. There is reason to expect that Lululemon’s brand and products will make a good fit with consumers’ tastes in that region.
Strong Quarterly Results: To break through the long-standing barrier at $80/share and finally make new highs, LULU stock needs a solid holiday season. If last quarter is any guide, things are trending well for the company.
The company grew revenues by almost 14% year-over-year this quarter. That marked the company’s best growth rate since June 2016. The company grew net income by 16%.
That even faster pickup reflected Lululemon’s rising profit margins as it regains pricing power as the memory of the product defects starts to fade. And given the company’s quickly rising cash position, it authorized a sporty new $200-million stock buyback.
Activist Investor: For investors in LULU stock, the last five years have been a disappointment. With the company’s great brand and seemingly strong growth potential, not surprisingly, now shareholders are getting more vocal.
Their wishes for a more active role in management’s strategy appear set to play out. Major LULU stock holder Advent International — which bought out half of the founder’s stake in 2014 — is getting more directly involved.
Lululemon appointed Tricia Patrick, a managing director at Advent, to their board of directors at the end of August. Ms. Patrick previously worked in private equity for both Goldman Sachs Group Inc (NYSE:GS) and Bain Capital.
She brings the sort of activist shareholder value-focused point of view that Lululemon appears to be lacking. While there is no guarantee that activist shareholder strategies can get the LULU stock price up, it’s a reason for optimism.
Verdict for LULU Stock
LULU stock isn’t cheap at the moment. And it’s up against a key resistance level where it has failed many times before. So there is plenty of reason to be cautious right now.
With that said, if you believe athleisure has more room to grow, LULU stock could have a lot more upside. Just wait for a break above the key $80 level. It’ll be a safer trade once the stock breaks out, and short sellers start feeling the need to cover their positions.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.