Lululemon Athletica (NASDAQ:LULU) stock has dropped by over one-third from its highs just last month. The question is why.
The simple answer is that U.S. stocks have plunged. But that’s kind of the point.
With few exceptions, investors have been indiscriminately selling off almost every stock in the market. And that has created opportunities to own quality companies at a discount.
Lululemon unquestionably is a quality company. That was true in February, and it’s true in March. Nothing has changed — except the price. For investors willing to ride out near-term volatility while keeping a long-term focus, that lower price is a buying opportunity.
A Short-Term Hit
The response to the coronavirus from China is going to provide a short-term hit for Lululemon. On Feb. 21, the company disclosed that its stores in China had been closed since Feb. 3. That wasn’t a surprise, or necessarily a death knell. The country only accounts for about 8% of Lululemon locations.
No doubt, investors have been worried about an impact on sales in the U.S. and Europe. Those fears might seem justified. On Sunday, the company announced that it was temporarily closing all of its locations in both regions.
And as offices and stores close across the United States, there are legitimate fears of a short-term recession. That may pressure demand for Lululemon apparel even once stores re-open.
This will be a difficult stretch for Lululemon. In fact, it will be a difficult stretch for the country. But it will be manageable — on both fronts.
The Impact on LULU Stock
Assume that Lululemon couldn’t generate any revenue for an entire year. How much should that, in theory, affect LULU stock?
Wall Street estimates for 2021 revenue average $4.55 billion. But, of course, Lululemon doesn’t lose $1 in profit for every $1 in lost sales. It only loses its gross profit on that $1.
Lululemon’s gross margins for fiscal 2019 (which ended January of this year) should come in around 55%. Assuming the same rate in a hypothetical 2020 with no coronavirus impact, Lululemon would have generated about $2.5 billion in gross profit.
That’s what Lululemon would lose if its business shut down for a year and it paid all of its rent and labor expenses in full. Yet the market capitalization of Lululemon Athletica stock has declined $12 billion in less than a month — almost five times as much.
Even that $2.5 billion figure is an obvious exaggeration. Lululemon isn’t going to shut its stores for a full year. It’s not even shutting down its business — its online sales will continue. E-commerce already drives over one-fourth of total sales. The company will find savings on labor and other operating expenses.
Rising recession risk might have an impact as well. But there’s little way to logically argue that risk accounts for $10 billion-plus in lost market value. This is a short-term overreaction, plain and simple. The math doesn’t work any other way.
Investors now can own one of the best apparel plays in the world at a discount. And make no mistake, this is one of the best apparel companies in the world. Nike (NYSE:NKE) is a world-class company. VF Corporation (NYSE:VFC), owner of brands like North Face and Timberland, is an oft-overlooked gem.
But neither company offers anywhere close to the growth that Lululemon does. Revenue should rise 20% year-over-year in 2019 off a base over $3 billion. Those gross margins of 55%? Among the best in the industry — because Lululemon’s loyalty drives significant customer loyalty.
Nothing has changed about the long-term opportunity for this company. There will be a short-term financial impact, yes. But the equity value erased in this decline is many multiples of that impact.
Lululemon stock has fallen so far because investors are panicking. Its decline in turn proves that investors are panicking.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.