Lululemon Athletica (NASDAQ:LULU), the Vancouver-based athleisure apparel company, reported another solid quarter last Thursday. But the third-quarter adjusted number fell short of analysts expectations, the valuation looked stretched and traders took profits, sending LULU stock down 4.4%.
The company reported net income of $126 million, 97 cents per sale, on revenue of $916 million, compared with net income of $95 million, 71 cents per share, on revenue of $747 million a year ago.
That’s 33% more net income on 23% more sales, with expectations of $2.10 per share in earnings from over $1.3 billion in sales over Christmas. But the stock fell by $14 per share in overnight trade, and only recovered one-third of that the next day.
The reason? Not to make yet-another yoga pun but the valuation is stretched. The market cap of $29 billion is 7 times this year’s anticipated sales, and 55 times earnings. Lululemon doesn’t pay a dividend.
The secret sauce of Lululemon should be replicable.
It designs a quality product for a market it understands. It controls its manufacturing in Southeast Asia. It also controls the entire distribution channel, selling only through its own stores or directly online. Lowcost, high price, works every time.
Other top brands are taking notice. Nike (NYSE:NKE) is expecting $11.75 billion of its revenue to come through direct channels this year, almost one-third of its total. Even discounters like Target (NYSE:TGT) are in on the trend, with store brands like Cat & Jack for kids becoming billion-dollar businesses, with high profits.
The question for Lululemon is how far it can stretch its niche, while retaining cachet and control.
If we were just talking yoga, I wouldn’t get it. I do yoga. It’s good for aging joints. But I don’t wear special clothes for it, and my mat still works well (with a little cleaning) after five years.
What’s happening is that Lululemon is becoming an “activewear” giant. That is, people are wearing Lululemon yoga clothes outside the studio. As with Nike, they’re buying the image and taking that image to the streets. I suspect some of these people don’t even do yoga.
Big League Brand
So far the Lululemon trend has survived parody but there has to be a limit.
Under Armour (NYSE:UA), which was the Lululemon of the last decade, found that limit when it lost its distribution channels. Before that happened I had proposed Under Armour buy Lululemon. Today Lululemon is worth about 3.5 Under Armours. Lululemon could also buy privately held Spanx for the equivalent of seat cushion money.
In short, Lululemon is now playing in a different league than before. Consider. Lululemon’s $29 billion market cap is now nearly six times Macy’s (NYSE:M), or L Brands (NYSE:LB), owner of Victoria’s Secret. Lululemon is worth five times Nordstrom (NYSE:JWN). But its net operating profit is not yet in the top 10 among fashion brands. (As an aside, if you want a deep dive on what ails apparel retailing, catch the podcast interview with Mickey Drexler, former CEO of Gap (NYSE:GPS) and J.Crew with food entrepreneur Dave Chang.)
Bottom Line on LULU Stock
I think it’s time LULU stock bulls realize the yoga pants maker is at a crossroads.
To keep growing it must expand its niche into areas where competition is tough, like shoes. Competitors are on to its one weird trick of controlling everything from production to final sale.
Yoga is fun, but Lululemon is now playing in the big leagues.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time available now at the Amazon Kindle store. Write him at email@example.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this story.