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Lululemon Athletica (NASDAQ:LULU) is a Canada-based manufacturer and marketer of athletic and yoga apparel in North America, Japan, and Australia. The company trades on the Nasdaq and the TSX with a market capitalization of $9.81 billion and 144.16 million shares outstanding.

This high-growth apparel company that enjoys robust margins on its merchandise has proven that its formula for success works. Focused on brand recognition and customer loyalty, Lululemon managed to grow its annual revenues at an average rate of 42% over the past three years. In fact, 2012 revenues slightly surpassed the $1 billion mark for the very first time.

Annual Revenues (in Millions) and Growth Rates

Click to enlarge images.

The company also enjoys strong margins on its operations. In 2012, the company posted a 56.9% gross margin, which in turn helped the company boost its operating margin to 29% -- a 4% improvement over 2011. The strong growth in revenues and robust margins has translated to an abnormal earnings growth rate -- a rate that tends to normalize over the long run. As the chart below illustrates, the company managed to increase its earnings per share substantially every year, which is well-reflected in the incredible run Lululemon's shares have seen the past few years. However, should investors dip their toes in at current price levels?

Annual Earnings per Share and Annual Growth Rate

Unfortunately, the answer is not exactly clear and is highly dependent on earnings estimates not only for 2013, but for the next few years. At a price of $68.04 per share, the company is trading at 53.6 times 2012 earnings of $1.27 per share. That rich multiple can rarely be justified. However, using some assumptions for future earnings growth, one can see the investment case for the company.

For instance, the chart below estimates 2013 to 2015 earnings (a three-year projection) at an annualized growth rate of 50%. It also demonstrates the P/E ratio at a price of $68.04 per share over the same time frame. As shown, at a 50% annualized growth rate, the company's rich multiple can be eventually justified by late 2014, early 2015 at a P/E of 23.8 times 2014 earnings.

Earnings per Share (LHS) and P/E Multiple (RHS)

On the other hand, estimating market conditions for the company's products and the impact of competition into 2014 and 2015 is highly difficult, if not impossible. Other retailers and athletic apparel manufacturers and marketers like Nike (NYSE:NKE) and Adidas are very likely to pose a threat to Lululemon's earnings growth in the future. This could mean that the company's earnings growth rate will subside or normalize in the coming years, leaving the company's shares extremely overvalued at current levels.

Given the risks inherent in investing at top valuations, investors at current price levels should be exceptionally comfortable with the earnings trajectory and the competitive environment Lululemon is part of. For those investors comfortable projecting a few years into the future and confident Lululemon can manage to maintain its current leading position in the market for yoga and athletic apparel, the case for investing in the company can be made. However, for those recognizing the difficulty in correctly estimating growth rates two to three years into the future and the unpredictable nature of any goods market in the long run, investing in Lululemon comes with high risk and substantial downside.

Source: Is Lululemon's Multiple Justified?