Be Wary Of Lululemon Athletica

Feb.19.12 | About: Lululemon Athletica (LULU)

The notion that Lululemon Athletica Inc (NASDAQ:LULU) is expensive would depend on whom you ask. Bears will be quick to point to the lavish multiple, while bulls justify the valuation with exceptional growth rates.

Looking at the past 2 months, bulls have certainly benefited. Since Goldman Sachs (NYSE:GS) added the company to its conviction list on January 4th of this year, the stock rallied a whopping 38 percent. The Goldman analyst left the $64 price target on the shares unchanged on that date.

The stock closed the week at $65.01, a $1 above the Goldman estimate and more than $2 above the average price target, according to Yahoo Finance.

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To add to the rosy picture, on January 10, 2012 the company raised its guidance for the fourth quarter of 2011 to a range of $0.47-$0.49 earnings per share from the earlier estimate of $0.40-$0.42.

Euphoric investors responded to the news by pushing the price to $59.87 from the previous close of $53.86. That's a $6.43 appreciation for an additional $0.07 in earnings.

The Euphoria Seems To Subside

The company will be reporting on March 8, 2012 for the fourth quarter of 2011, which might create another 3-5 dollars of upside in the short-run.

Otherwise, technical indicators are pointing to complacency among investors. As the chart below illustrates, volatility represented by the spread of the upper and lower Bollinger bands is notably low. The last time investors were this complacent and prices were similarly elevated was in late July of 2011.

The RSI is also pointing to subsiding interest as it trends down from the 70 level, which it remained above, or at since early January. This trend can also be noted in late July of 2011.

Discounting Too Far Into The Future

Although the company did not report yet, it is prudent to understand that the additional 3-5 dollar upside comes with significant risk.

According to the consensus estimate, the company is expected to generate earnings of $1.59 a share in fiscal 2013. This puts the forward multiple at 40.9, which is not outrageous if the company can continue to generate 38-45 percent in annual earnings growth. However, can it?

Competitors like Nike (NYSE:NKE) and other apparel retailers are taking note of the yoga apparel market and are making their move. Students of history know very well that exceptional growth rates normalize over time as competition intensifies.

It is therefore not reasonable to pay $40.90 for every $1.00 of the company's 2013 earnings. It simply discounts too far into the future; a future that might prove to be very hard to forecast.

Hence, investors should steer clear of Lululemon until prices better reflect a more normalized future growth rates. In this case, the mid-term risk is to the downside, not the upside.

Disclosure: I am short LULU.