Lululemon Athletica: Any Stretch Left In Its Stock?

 Ticker: LULU

Rating: Overweight

Target Price: $385-$400

Target Date: 10-12 Months

Market Cap: ~$420 Billion

Current Stock Price (June 6, 2021): $320

🚀 Know The Company:

Market Sector: Consumer Cyclical

Market Segment: Company-Operated Stores (38% of FY2020 revenue), Direct to Consumer (52% of FY2020 revenue), Others incl. MIRROR (subscription-based fitness classes)

Products: Sports Apparel (especially for Yoga and Athletic activities), Shoes and Accessories

Scope of Activity: 521 stores as of January 2021, mainly catering for the USA, Canada and China; e-commerce sales in North America and a few other markets

Major Brand's created/acquired: Lab (luxury streetwear), MIRROR (acquired)

🔑 Key Takeaways:

• Lululemon has continued increasing its market share steadily and has also simultaneously improved its operational efficiency. With the acquisition of the MIRROR brand, it has initiated a horizontal expansion of their business and has tasted success in that venture. Moreover, it has achieved early success in its power of three strategy, managing an almost 50% increase in its revenue outside North America.
• While the stock's fundamentals are encouraging, the stock does have a rich valuation at the moment so the risk in the short term is greater. That is why we're recommending a long term play as from the long-term growth perspective, the stock has a lot to offer and can prove to be a worthy investment providing stable growth at moderate risk.

📊 By The Numbers:

When looking through the numbers we see some highly encouraging metrics across all of their business units. The strongest numbers came across revenue, gross profit margins & operating margins. What does this mean? Let's break it down further:

1. Across the board we saw that they managed to perform extremely well in the COVID-plagued year, accounting for $4.4 Billion in total revenue, as compared to ~$4 Billion in in 2019 (10% growth). Their gross profit margin also increased by .1% from 55.86% in 2019 to 55.96%.
2. While the growth isn't "insane", it is VERY impressive that they did this throughout COVID. Why? The entire retail sector's sales were down significantly as people were not buying anything they did not need. The fact that they not only maintained their margins and revenue but increased it, is a true testament to the strength of their overall business.
3. While the operating margin dropped by 3.7% of revenue, it was largely due to higher selling, general and administrative (SG&A) expenses. The company stated that the SG&A expenses increased mainly due to higher distribution costs (door to door delivery) and digital marketing expenditure.
4. They also said that these numbers should not persist meaning that margins will shoot back up. A sign that this was not ongoing is very positive.
5. The company held cash and cash equivalents worth $1.15 Billion at the end of the reporting period – an increase of $57 Million during the year. The net cash flows generated from the operations during the year were just above $800 Million.
6. With such a massive balance sheet, Lululemon has the flexibility to either reinvest in its business, reward its shareholders or acquire new businesses to inorganically fuel growth. This gives them a tremendous advantage in the marketplace especially in a team where companies were burning through capital.
7. One of the most remarkable developments during the year has been the company’s switch from physical stores to online sales during this year. The company’s revenue from Direct-to-Consumer sales represented 52% of its total revenue, as compared to 29% in FY 2019, increasing by 101% YoY. The extraordinary growth in this segment ensured that the overall business wasn’t hit hard as its dominant segment (physical sales) faced the brunt of the pandemic.
8. Again, this signals major strength of the business and proper decisions on behalf of the management team. With a strong planned transition from establishing an in-person brand to and e-commerce based, higher margin store, LULU made a wide business decision that is not only paying off now but will continue to pay off into the future.

📈 Growth Prospects:

Despite the remarkable operational performance and the strong fundamentals achieved by the company, the market response to the stock has been lukewarm at best. The stock prices of LULU, in the last 12 months, have grown merely ~5% ($309 on June 1st, 2020 to $320 on June 1st, 2021). The competitors’ stock price, on the other hand, soared by more than 50% in the same period. While that is not encouraging for the stock it makes us believe that the market is discounting the apparent growth. This also leads us to believe that with discounting growth, a strong surge lead to a strong buying opportunity thus driving the price quickly up.

While the 5Y monthly Beta of the stock (1.34) signifies that the stock is slightly riskier as compared to the benchmark index. While this isn't necessarily a bad thing, it is interesting when overlapped with the above. If LULU catches fire, the historical beta shows that the run could spark serious upside.

The beta measures the volatility of a stock, taking a benchmark index (eg. Dow Jones Industrial Average) as a base. Security with a beta above 1 is considered riskier than the overall market. However, higher beta also means greater upward movements, and therefore is not always a negative sign, especially when the stock has strong fundamentals.

With this in mind, as we enter the post-COVID period, the athletic apparel and luxury industry is expected to experience a huge momentum boost. Taking into consideration the operating efficiency and the ensuing profitability of the company, it may register another wave of price growth.

💰 Valuation:

As we've said before the price of the stock doesn't come cheap. And while many may think it is overvalued, we strongly believe it is more-so due to weaker numbers amidst a tough time rather than any underlying issues. As we've stated above the company was one of the only ones of it's peers to not only maintain but grow during the pandemic, hence the massive dip that never came. We believe this is strongly contributing to the stock's recent underperformance and that more outperformance from a growth perspective could be the catalyst needed to fuel growth over the long term.