A50% year-to-date drawdown at Canadian athleisure company Lululemon Athletica (LULU:NASDAQ) presents a buying opportunity for investors who love to snap up quality merchandise at a discount.
Until recently, Lululemon, which sells clothing and footwear for yoga, running and training, was a stock market darling admired for its record of beating Wall Street estimates, but the stock has de-rated on concerns over a slowdown in North America, its largest market.
Yet Shares believes the $31.2 billion cap still has a significant runway for growth, and so long as Lululemon demonstrates progress against management’s ambitious ‘Power of Three ×2’ strategy there is scope for a material re-rating, perhaps beginning with the second quarter results on 29 August.
Ongoing share buybacks should provide share-price support, while the commencement of dividend payments down the track offers a potential future catalyst for the stock.
STRETCHING FOR GROWTH
Guided by chief executive Calvin McDonald, Vancouver-headquartered Lululemon is an upmarket exercise-kit seller whose stylish-yet-functional products are designed with and for athletes.
Lululemon’s wide product range spans everything from yoga pants and mats to leggings, shoes, hoodies, tanks tops and belt bags, and while historically the core demographic has been women, its men’s line is growing steadily demonstrating the broadening appeal of the brand.
Shares believes the company offers a play on global trends towards healthy and active lifestyles and could even prove a beneficiary of weight-loss drugs, should their wider adoption drive a wardrobe replacement cycle.
Despite its evident success in North America, Lululemon’s big growth potential lies in international expansion particularly in Asian markets including China.
The company has consistently outpaced its competitors with rapid revenue growth and has many hallmarks of quality; Stockopedia shows operating margins routinely topping 20% while ROCE (return on capital employed) was a bumper 39.1% in the year to January 2024, up from 32.3% in fiscal 2023 and comfortably ahead of the 22.9% notched up by Nike (NKE:NYSE) in its last financial year.
THIS BUFFETT ADMIRER IS BULLISH
Warren Buffett fan Michael Crawford has been buying Lululemon for his WS Chawton Global Equity Income (BJ1GXX3) fund and recently informed Shares that the company is ‘transitioning’ from explosive growth to a more mature phase.
‘At that point you always get a more volatile share price,’ explained Crawford. ‘Up until very recently, Lululemon had been growing very fast both in the US and globally and was on a very high PE (price to earnings) ratio, well over 30 times. But in the last year the growth level has subsided and there’s talk of Lululemon losing its brand cachet. But we think the brand is sustainable and there is still a fair amount of growth ahead, particularly in Asia where high-end yoga athletic apparel is gaining traction. There are growth possibilities in the US and this is a good opportunity to get into a high-quality compounding situation.’
Crawford also observed that management has been clever with its capital allocation. ‘Around 50% or more of the business is e-commerce, so that is more attractive than having to invest a lot in physical assets. And the thing about Lululemon is it is quite an expensive product and you don’t want to saturate the market, so they are quite specific about their store expansion profile.’
Stockopedia shows Lululemon sells for 18.3 times forecast earnings for the year to January 2025, falling to 16.8 times January 2026 estimates, a rating which we think undervalues the group’s long-run prospects.
CAVEAT EMPTOR
Having ballooned during the Covid crisis, Lululemon’s inventory levels have now normalised and in a testament to the brand’s resilience, turnover still ticked up 10% to $2.2 billion in a tougher first quarter ended 28 April, including an impressive 35% surge in international sales.
Ahead of its second-quarter results, Lululemon has guided for net revenue in the $2.4 billion to $2.42 billion range, which would represent growth of 9% to 10%.
For the current full year, analysts are looking for growth in net profit from $1.55 billion to the best part of $1.8 billion, stretching to $1.9 billion by 2026, although for balance, we must highlight that Jefferies has an ‘underperform’ rating on the stock following its recent store visits and believes consensus estimates are ‘too optimistic’.
The broker believes Lululemon’s discounting levels have ‘likely increased’ and flags risks around increasing competition, a softening athletic apparel backdrop and US consumer spending which is becoming ‘more volatile’.
These articles are provided by Shares magazine which is published by AJ Bell Media, a part of AJ Bell. Shares is not written by AJ Bell.
Shares is provided for your general information and use and is not a personal recommendation to invest. It is not intended to be relied upon by you in making or not making any investment decisions. The investments referred to in these articles will not be suitable for all investors. If in doubt please seek appropriate independent financial advice.
Investors acting on the information in these articles do so at their own risk and AJ Bell Media and its staff do not accept liability for losses suffered by investors as a result of their investment decisions.
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