After a Strenuous Run, Lululemon Stock Needs to Cool Down

The long-term growth story for Lululemon is still strong, but LULU stock needs a rest first

LULU stock - After a Strenuous Run, Lululemon Stock Needs to Cool Down

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Lululemon Athletica (NASDAQ:LULU) is up 90% year-to-date and 144% over the past 12 months. To put it simply, LULU stock has been nothing short of breathtaking.

This time last year, analysts were full of concern about the company’s business model. The company’s e-commerce efforts needed more focus. Chinese expansion was a question mark. Heavy competition threatened from other sports apparel companies. And the lingering worry remained that perhaps yoga clothing in particular was just a fad.

However, Lululemon has blown all these questions out of the water. In fact it’s hard to think of any retailer that has had a more impressive start to 2018. Despite all that, however, given the massive move in LULU stock, it’s time to consider just how steep a valuation the business can support.

A Great Quarter for Lululemon

Lululemon put up another amazing earnings report. Its second quarter results blew away estimates, with the company growing same-store sales by a blistering 10%. That’s almost unheard of in retail nowadays.

On top of that, the company’s omni-channel strategy is paying off in spades. Lululemon scored a jaw-dropping 48% increased in direct-to-consumer sales, which led to overall sales gains of 25% for that quarter. Make no mistake, these are fantastic numbers.

As if that weren’t enough, there’s even more good news. The company’s efforts to diversify away from the core North American female market are working. Male apparel rose to 22% of overall sales, which is quite strong, given the company’s image and branding. And in China, e-commerce revenues soared more than 200%, leading to terrific numbers for international in general.

Given these strong results, management delivered a huge guidance boost as well. The company now sees full-year earnings coming in at a midpoint estimate of $3.49 per share of LULU stock, up sharply from previous guidance of $3.14.

But LULU Stock Has Stretched Too Far

I’m far from a long-term bear on LULU stock. Last December, in an article weighing LULU stock’s pros and cons, I suggested that if Lululemon topped resistance at $80/share, it would be set to run to $100 or higher. Technical breakouts tend to lead to strong follow-through, and that suggestion has played out better than anyone could have hoped.

That said, I was looking for LULU stock to move to $100 or maybe a little past that. Above $150 is a different matter altogether. Let’s say 30x earnings is a fair price for a fast-growing retailer like Lululemon. The exact multiple is debatable, but 30x is in the right ballpark.

At Lululemon’s old guidance of $3.14 a share in earnings, the stock was worth about $94 per share. The guidance raise now lifts that figure to 30x earnings on $3.49, for a stock price of $105. That’s a healthy addition to fair value, but it’s far from doubling up on the company’s value. Needless to say, with the stock having moved from $80 to $151 inside of a year, it takes a massive amount of value creation to support such a run.

Sellers Starting To Appear

It seems that LULU stock may have hit an intermediate top after its recent earnings report. On two successive trading days, LULU stock hit $160 but went no higher. Since then, shares have dipped to as low as $151 on Thursday and Friday.

Technically speaking, from a chart perspective, it seems like risk is to the downside. The stock gapped straight up from $140 to the high 150s, and sellers will be looking at any further decline as an opportunity to drop it back to $140 or lower.

Additionally, bears have sold less than 5% of LULU stock float short. That means that despite a massive run, there still isn’t much interest in betting against the company yet. However, expect short interest to grow over time as more bears lock-in on the company’s huge valuation. On top of that, the relative absence of short sellers in the stock makes it much harder for the stock to squeeze above $160 and on to new highs at the present time.

LULU Stock Valuation Strains Credibility

LULU stock deservedly commands a premium valuation. Given that management has pushed the right levers to get growth going on a variety of fronts, Lululemon deserves to be trading higher than its apparel peers. Don’t expect to see the old sub-$80 prices for the stock again.

That said, a few good quarters haven’t doubled the fundamental value of the company either. At current prices, the company is trading at more than 50x trailing earnings. That’s way up there. What other retailers have traded at that sort of valuation recently? Not many, that’s for sure. Even granting that earnings growth comes as quickly as expected, Lululemon is at 37x forward earnings. That’s still far too much.

For all the controversy Nike (NYSE:NKE) is currently having with its Colin Kaepernick ad, its position as the industry leaders remains undisputed. And like Lululemon, it is having great success with direct-to-consumer and international sales. Despite a massive move higher in NKE stock as of late, it is selling at 33x trailing and 26x forward earnings. It’s really hard to justify LULU stock at a way higher multiple than the industry leader, which is also growing strongly at this time.

Lululemon is doing everything right on a corporate level. Their last earnings report was nearly flawless, continuing the company’s recent winning streak. But at the end of the day, retailers don’t sell at 50x earnings. The price is wrong, and with the stock massively overbought, expect a deeper correction in the price of LULU stock soon.

At the time of this writing, Ian Bezek held no positions in the aforementioned securities.

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