Lululemon: Suburban Yoga Cult Or Investment Growth Opportunity?

| About: Lululemon Athletica (LULU)

On January 4th, Goldman Sachs analyst Michelle Tan upgraded Lululemon (NASDAQ:LULU) to the conviction buy list, setting a six month price target of $64. In an almost self-fulfilling prophecy, LULU reached over $62 by January 10, to end the day at $59.68. LULU had boosted its guidance for the fourth quarter, resulting in an over 11% surge in its share price. Over the next two weeks, LULU has drifted higher to $64, meeting the price target previously set forth. The question for investors becomes whether LULU has room to rise even higher, despite questions regarding inventory supply; or is it overvalued, taking into account the costs of expansion.

The back story to LULU is certainly an interesting one. Many are unable to understand the almost rabid demand among the company's devotees for $100 yoga pants, and logically question the growth of this niche luxury market. Moreover, LULU has encountered some recent negative publicity. On March 11, 2011, an Apple (NASDAQ:AAPL) store employee overheard the cries for help of a LULU employee who was murdered by another co-employee. Brittany Norwood was eventually convicted of the first-degree murder of Jayna Murray. This horrendous incident, while obviously not condoned by management and the act of one individual, does lend itself to creating a murky side to the LULU.

Further, LULU management strongly suggests that its employees attend Landmark Forums, which many skeptics have derided as akin to brainwashing. It has been reported that employees are rewarded with admission to a Landmark forum after their first year on staff. LULU founder Chip Wilson has used the concepts taught by the Landmark forums and other sources - such as those from the popular book "The Secret" - to create an almost cult-like following for his company's products. In addition, LULU has focused on grass roots marketing with its local ambassadors program, which allows it to establish a strong presence in communities. So far, the company's approach appears to be working.

LULU revenue has grown from $148 million in 2007 to $711 million in 2011. Net income grew from $52.28 million in 2010 to $121.85 million in 2011. With its rapid revenue growth, LULU appears well on its way to becoming a billion dollar revenue generator. LULU opened 27 new stores through the end of the third quarter, for a total of 165 stores, with plans to move into new markets as appropriate.

Still, the question becomes, how much further can LULU expand? As others have commented on the site, it would seem that this luxury market can only sell so many pairs of expensive yoga pants. LULU may need to move into other product offerings and markets to continue its explosive rate of growth. LULU has a current market capitalization of over $9 billion, compared with a market capitalization of $3.98 billion for competitor UnderArmour (NYSE:UA). While significantly less than industry leader Nike (NYSE:NKE), with its market capitalization of $47.97 billion, LULU needs to seriously consider expanding into other lines of athletic clothing, either through new product innovation, or acquisition of smaller athletic clothing/fashion retailers. Chip Wilson has a background in the surf and ski industry business; LULU should take a page from Nike's playbook and consider expansion into the skateboard and snowboard industries. Although LULU appears to be expanding into the girls' gymnastic area with ivivva athletica, continued growth of LULU may depend on the company dipping its toes into other product lines and markets.

So, where does LULU's share price go from here? As noted previously, LULU's stock price has ranged from $34.02 to recently hovering near its 52 week high of $64.51. The current price is significantly above the 50, 100, 200 SMA. The price seems to be hitting some resistance at $64.50, having touched that level a couple of times within the last trading week. We may be seeing the formation of the down-side of the head in a bearish head and shoulders pattern. Other contributors on this site have noted that LULU is trading with a high p/b ratio, forward p/e ratio, and beta, compared with UnderArmour, thus subjecting it to increased volatility. The significant gap up in price from 1/9 to 1/10 makes it difficult to ascertain where longer-term price support lies, although there does appear to be short-term support around $60. The OBV appears to be decreasing generally from November to January. Short interest as listed by NASDAQ was 12,889,502 with 2.5 days to cover based upon the current trading volume. This is nearly 2 million shares lower than what was reported on 12/31/11. It appears that the buyers may be slowly leaving the market for this stock after extremely high volume on 1/10.

Short term analysis indicates LULU may be in for a price correction of some sort, although it is impossible to tell how much lower it may go. The long term prospects for LULU depend on its ability to intelligently expand its retail stores, market growth, and its ability to expand into other product lines. Chip Wilson has recently stated that he is leaving his management role for the company, but will keep his position on the board of directors. This may signify a sea change in management focus, whereby the next few years will prove pivotal for the future of the company.

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

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