Lululemon (LULU) has had a magnificent run since the depths of the market crash of 2008/2009. It has risen over 1000% in that time, including a 30% increase just since the beginning of the year. LULU has approximately 125 stores currently and plans to open another 20-25 stores in the United States this year. It sells yoga and other athletic wear. It has consistently beat revenue and earnings estimates over the last 18 months. That being said, based on valuation and other factors I believe this stock is way overdue for a substantial pullback of 25-40% sometime by the end of year. I based this opinion on the following:
VALUATION: LULU sells at approximately 9 times sales and close to 45 times projected earnings for 2011. Although it is true that LULU’s earnings estimates have been rising since the last earnings reports, I find to hard to justify a valuation that assigns a 50mm value to each of its existing stores, especially given the size and sales per store. Nor can I think of any other apparel company that has as high a value per square foot of retail space.
COMPETITION: Both Nike (NKE) and Gap (GPS) has started to focus more on the same market demographic with similar products. Given their marketing budgets and expertise, I find it likely that these efforts will either result in LULU’s having a hard time expanding market share or having its margins impacted eventually by its competitors' efforts. Yoga and athletic wear are hardly unique products after all.
OTHER FACTORS: Where to start? I hardly find the $40mm of insider sells since the beginning of the year reassuring. Rising prices for clothing materials will hardly help margins. In addition, LULU is a classic high beta momentum play that has been a primary beneficiary of the massive increase of liquidity engineered by Bernanke’s printing press and Quantitative Easing (QE2). A good portion of the additional liquidity has found its way into the riskiest assets and commodities. With QE2 ending by the end of quarter, LULU and other high beta stocks should be among the first asset classes to be punished.
PROGNOSIS: This stock has had a huge run. If you have had this equity during this runup, congratulations. However, I don’t think this stock justifies its valuation and there is a good possibility in my opinion that you will be able to pick LULU up in the sixties by the end of the year.