The shares of red-hot athletic apparel brand Lululemon (NASDAQ:LULU) dropped slightly in mid-June after the company reported sub-par first-quarter numbers that came in below analysts’ average earnings and profit expectations. The miss was due to the novel coronavirus pandemic. The slight drop of the shares came on the heels of a meteoric, 100%+ rally by LULU stock since mid-March.
Does this post-earnings drop signal the end of the rally? Or is it a buying opportunity?
For three main reasons, I think the latter is the case.
- Although its headline results missed average estimates, Lululemon’s Q1 earnings were strong and illustrates that it is a best-in-breed retail name.
- Its growth trends will improve rapidly in Q2, Q3 and Q4 as its stores reopen and consumers regain their confidence.
- LULU stock remains undervalued relative to the company’s promising, long-term profit-growth potential.
All in all, then, I recommend buying the dip of LULU stock. It is a long-term winner, with accelerating momentum and a reasonable valuation.
Lululemon’s Earnings Were Strong
Although Lululemon’s earnings came in below average estimates, the firm’s underlying numbers were actually quite strong.
Before Covid-19 became a worldwide pandemic in March, Lululemon’s comparable sales were rising by around 20% year-over-year, which matched the company’s strongest gains in several years. Importantly, the 20% c0mp sales gain in February came when all the company’s stores were closed in China. If its stores in China had been open in February, one can reasonably assume that Lululemon’s comp sales then would’ve been as hot as they’ve ever been.
Then Covid-19 emerged, and Lululemon was forced to close most of its stores across the globe. As a result, the company’s red-hot sales growth faltered.
But its e-commerce business stepped up a great deal. In Q1, its e-commerce sales rose 70% YOY. Its growth accelerated to 125% in April, and management expects it to surge at least 100% in Q2.
The rebound of the apparel maker’s e-commerce revenue shows how strong demand for the Lululemon brand is, indicating that, regardless of the broader economic or sociopolitical conditions, consumers are going to find ways of buying Lululemon’s clothes.
Indeed, amid the pandemic, the firm’s management, citing NPD data, reported that Lululemon had increased its share of the athletic apparel market by the largest amount in several years.
Overall, while Lululemon’s Q1 numbers were hit hard by the pandemic (its sales sank 17%, its gross profit retreated 21% and its operating profit tumbled 75%), its underlying trends were actually quite strong. Its resilience shows that Lululemon is a best-in-breed retail apparel brand.
Lululemon’s Growth Trends Will Improve Rapidly
Lululemon’s Q1 earnings report and comments by its management made in conjunction with the results also strongly indicated that the company’s growth trends will rapidly improve during the rest of the year.
For example, in China, Lululemon began reopening stores in March. In that same month, its comparable sales there turned positive. They climbed by around 13% in April, and they have been advancing by around 20% in recent weeks.
Lululemon’s China business has gone from completely shut down to completely normal in about three months.
The firm’s business everywhere else in the world should rebound similarly.
Lululemon started reopening its stores outside of China in May, as closures around the world began to be lifted. On its Q1 conference call, the retailer said that traffic at its reopened stores was trending ahead of its expectations. Assuming that trend persists, by August Lululemon’s total comparable sales growth rates could be back to 20%.
Thus, by the second half of 2020, Lululemon’s numbers could be very similar to its results during the same period a year earlier. Specifically, its comp sales may jump 20%, its revenues could surge 20% and its gross margins and operating margins could expand, with its profits soaring more than 20%.
As the company moves from its revenue sinking 17% YOY to 20% revenue growth in the second half of 2020, LULU stock should outperform.
Lululemon’s Stock Is Reasonably Valued
The biggest criticism of LULU stock at its current levels is its valuation.
It’s trading at ten times its trailing sales. 72 times its forward earnings (based on analysts’ average 2020 earnings per share estimate), 20 times its book value, and 60 times its cash flow.
The stock isn’t cheap. But its premium valuation is warranted by its promising long-term profit growth potential. Indeed, based on the firm’s long-term outlook, LULU stock isn’t overvalued. Rather, trading below $300, it may be undervalued.
Lululemon is the hottest brand in the hottest apparel retail category in the world. The positive catalysts supporting the robust growth of the global athletic apparel market will persist. That’s because the rise of social media has inspired a new generation of consumers who lead active, healthy and fit lifestyles.
Meanwhile, the positive trends supporting Lululemon’s share gains in that market will also persist, driven by its geographic expansion, the growth of its men’s business and the strength of its brand among its core female, high-income customers.
Those favorable trends will continue to support 10%+ revenue growth by Lululemon for the next five to ten years. Its gross margins should improve as demand for its products rises, while its growth should increase its profitability. Its share repurchases will increase its EPS. And, ultimately, Lululemon’s EPS should climb at least 15% annually over the next decade.
As a result, I estimate that Lululemon’s 2030 EPS can reach $30. Based on a 25-times forward earnings multiple — which is the historical average multiple for Nike (NYSE:NKE) — and a 10% annual discount rate, that equates to a 2020 price target for LULU stock of more than $300.
The Bottom Line on LULU Stock
As shown by the company’s Q1 results, Lululemon’s stock is a long-term winner. As a result, the current weakness of the stock will pass. Once it does, the shares will resume their longer-term uptrend.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not hold a position in any of the aforementioned securities.