Lululemon Declines On Mixed Results: Is Now The Time To Buy?

Dec. 2.11 | About: Lululemon Athletica (LULU)

Shares of Canadian apparel maker Lululemon (NASDAQ:LULU) fell 5% on Thursday after a mixed earnings report. Diluted earnings per share of 27 cents beat by 2 cents, but revenues of $230.2 million came in a bit light, versus expectations of $235.74 million. For the fourth quarter, revenue guidance of $327 to $332 million was a bit ahead of the $327.3 million currently forecasted. However, guidance of 40 to 42 cents was a tiny bit light. Expectations currently call for 42 cents.

So let's break down the numbers. Revenues did grow at 31% year over year, down from the 55.7% growth in last year's quarter. Obviously, growth numbers will come down over time, but the growth appears to have slowed down a little more than most expected. The good news is that as you work your way day the income statement, year over year numbers increased by higher percentages, as you can see from the following table (numbers in millions). While revenues grew by 31%, net income grew by nearly 51%. Over the past four years, sales have grown by a lovely 254%. Operating profit is up 388%, and net income is up 413%.

Sales/Earnings 3Q 2007 3Q 2008 3Q 2009 3Q 2010 3Q 2011
Revenues $64.93 $87.05 $112.89 $175.80 $230.22
Growth - 34.07% 29.69% 55.73% 30.95%
Gross Profit $35.52 $41.89 $56.34 $96.83 $128.50
Growth - 17.96% 34.48% 71.88% 32.70%
Operating Profit $12.25 $13.06 $20.93 $42.38 $59.72
Growth - 6.60% 60.29% 102.50% 40.93%
Net Income $7.57 $8.83 $14.07 $25.70 $38.79
Growth - 16.71% 59.25% 82.69% 50.94%
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Lululemon has done a nice job increasing margins over the past couple of years, as evidenced by the next table. They had a down year in 2008, but a lot of companies did, and they've done a great job since then. Gross margins this quarter did not increase a lot over last year's (74 basis points), but improvement is still positive. Operating margins increased 184 basis points thanks to lower general expenses. The company also benefited from a $528,000 increase in "other income", which boosted its pre-tax margins. Combined with a lower tax rate (35.5% this year versus 38.9% last year), the net margins saw a huge increase. I don't think you'll see as big of a tax rate decrease next year, so I wouldn't expect as much of an increase to net margins from that respect in 2012.

Margins 3Q 2007 3Q 2008 3Q 2009 3Q 2010 3Q 2011
Gross Margin 54.70% 48.13% 49.90% 55.08% 55.82%
Operating Margin 18.86% 15.00% 18.54% 24.10% 25.94%
Net Margin 11.66% 10.15% 12.46% 14.62% 16.85%
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Lululemon has also seen higher margins over the past twelve months than the two big US names, Nike (NYSE:NKE) and Under Armour (NYSE:UA). While their businesses aren't 100% the same, they still are competing in some aspects.

Margins (ttm) LULU NKE UA
Gross Margin 57.59% 44.87% 48.19%
Operating Margin 27.69% 13.43% 10.41%
Net Margin 18.90% 10.19% 6.37%
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In the third quarter, Lululemon opened or acquired 18 new stores, the most of any quarter so far this year. The company opened 14 new stores during the first half of 2011. At the end of the third quarter, the company had 165 open stores, compared to 133 at the beginning of the year, a 24% increase. In case you are curious, total gross square footage has increased by nearly 26% so far this year.

One of the things I really like about this company is its improving balance sheet:

Financials 3Q 2007 3Q 2008 3Q 2009 3Q 2010 3Q 2011
Current Ratio 2.57 2.30 4.21 4.85 5.18
Working Capital $56M $61M $127M $247M $345M
Debt Ratio 30.88% 29.17% 21.95% 22.03% 16.82%
Cash $36M $52M $102M $225M $277M
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Lululemon does not have any debt, so a majority of its liabilities are accounts payable and other small liabilities. The company does not have to worry about huge interest payments or a heavy debt burden. The current ratio has improved significantly over the past few years, and the company has increased both its cash and working capital balances. It's liabilities to assets ratio has come down nicely as well. This balance sheet is sparkling. There are no cash flow problems here, so this is not a company you need to worry about it terms of its financials. In fact, Lululemon's balance sheet has been one of the best out there recently. As a comparison, Nike's current ratio is 2.94, and Under Armour's is 3.21. Nike's debt ratio is 33.13%, while Under Armour comes in at 34.23%.

Now Lululemon shares ended down 5% on Thursday, but closed near the highs of the day at $47.17. They were below $42 at one point. There seemed to be a fair amount of buyers coming in during this morning's selloff, as the drop seemed overblown to many. However, it does trade at a rather high multiple, currently at 44 times trailing twelve month earnings. Nike's trailing P/E is under 21, and Under Armour trades at 49. In terms of forward P/E, Lulu is still cheaper than UA (32.5 versus 35), but still well above the more established Nike, which is expected.

I'm not ready to recommend the name at $47. However, I would use today's low point as your entry guide. I think the low $40s is a good entry point for the name. At $43.50, it would be trading at 30 times next year's earnings (ending Jan. 2013). That is a good entry point in my opinion for a starting position, and I would accumulate more at lower levels. The company is still expected to grow revenues by about 34% this year and 27% next year, so you will be paying slightly for that growth. However, you're not paying an arm and a leg. You're still getting earnings growth this year in the mid 40s percentage wise, and about 26% next year. You could certainly do a lot worse. Coming into today, the average analyst price target was $56, but we'll have to wait a couple of weeks to see how that changes.

All in all, Lululemon reported a good quarter, but it could have been better. I would have liked to have seen a little more revenues come in, but the company did beat on the bottom line. Reversely, the guidance for next quarter was good on sales but bad on earnings. They have not missed on the bottom line in the past five quarters at least, so this could just be conservative guidance. The company is still growing margins, which are higher than comparable names. Lululemon is debt free and boasts one of the best balance sheets out there. I like the name, but I think you can get it lower, as I think we rallied a little too much throughout Thursday.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.