Yesterday, Lululemon (NASDAQ:LULU) announced first quarter results. Along with the first quarter results, the company announced a new $450M share buyback program. The announcement of the share buyback program was largely overshadowed by the disappointing first quarter results. Lululemon's shares dropped almost 16% in one day. Since the start of this year, the company lost 36% of its value. In this article, I argue that the new share buyback program creates some value for shareholders. I find there is no additional value with regard to the potential tax benefits. However, I do find that the timing of the buyback program in relation to the company's current valuation should create value for the shareholders.
Lululemon designs, manufactures and sells athletic apparel for men, women and young females through the company's own retail channel and e-commerce sales. Lululemon is well known for its yoga clothing. The company was founded in 1998 and is headquartered in Vancouver, Canada. Lululemon's main competitors are Nike (NYSE:NKE), Adidas (OTCQX:ADDYY, OTCQX:ADDDF) and Under Armour (NYSE:UA).
More information: lululemon.com
According to the company's first quarter earnings release, Lululemon intends to create shareholder value through a $450M share buyback program. Lululemon expects that the program is completed by the end of June 2016. The official press release stated:
The share buyback program is intended to create shareholder value by making opportunistic repurchases during periods of favorable market conditions and is expected to be completed in two years. Shares may be repurchased from time to time on the open market, through block trades or otherwise. Purchases may be started or stopped at any time without prior notice depending on market conditions and other factors.
In this previous article, I argued that companies can create shareholder value through a share buyback programs. I indicated two possibilities to create shareholder value. First of all, financing the share buyback program with long-term debt creates value, because interest expenses are deductible expenses. As a result, the tax bill is lower and the government "pays" for a part of the share buyback program.
Second, I stated that opportunistic repurchases could create value for shareholders. The company's board of directors could use their information advantage to repurchase shares in case they find the company is undervalued. In that case, the board signals confidence in the future. Unlike the debt argument, this argument is harder to quantify. I will focus on the valuation of the company in a historic perspective and related to the main competitors.
Along with its first quarter results, Lululemon's board announced a $450 million share buyback program. However, the board did not provide any information regarding the way this program is financed. For example, the company did not make any announcements regarding an upcoming long-term debt offering. Therefore, I assume that Lululemon intends to finance the program out of its current cash surplus and free cash flow in the future.
Based on Lululemon's latest balance sheet (see above), it is even more likely that the company will finance the program out of its current cash surplus. Lululemon has $752M in cash and cash equivalents. Even without the free cash flow in the next two years, the company has enough cash surplus to finance the buyback program. As a result, the buyback program does not provide maximum value for shareholders with regard to the potential tax benefits.
Lululemon expects to earn $1.55 per share this year. This equals a trailing P/E ratio of 24, based on yesterday's closing price. I reviewed the company's trailing P/E ratio in relation to the average P/E ratio during the past five years (see graph below). I find that Lululemon currently trades at a historically low valuation. The announcement of the share buyback program signals that the company's board recognizes Lululemon is undervalued from a historic perspective. Therefore, the timing of the buyback program should create value for shareholders.
As a robustness check for my findings, I compared Lululemon's valuation with the company's main competitors Nike, Adidas and Under Armour (see table below). Lululemon's valuation is in line with the company's two largest competitors: Nike and Adidas. Further, Lululemon's valuation is far lower compared to another fast growing athletic apparel company: Under Armour. I find no indications that Lululemon is overvalued. In fact, the company is undervalued compared to its closest peer Under Armour. As a result, my findings that the buyback program should create value for the shareholders still stand.
Overall, I believe that Lululemon's $450M share buyback program will create some value for shareholders. It is not likely that the company will not use long-term debt to finance the buyback program. Therefore, the potential tax benefits with regard to the deductible interest expenses do not apply. However, I find that Lululemon trades at an attractive level (following this year's decline). As a result, the buyback program should create value for shareholders if the company is able to repurchase shares around the current share price of $37/share.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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