I respect Lululemon Athletica (NASDAQ:LULU). They capitalized on the athleisure trend to build a strong and thriving multibillion dollar business, which I believe will be around for a long time. With that said, I do question their ability to outgrow their competitors in the long-term as they face strong competition, the potential of a dying fashion trend, and decreasing margins. However, Lululemon seems far more confident, projecting revenues $4.6 billion and net profits of $600 million by 2020.
From an investment standpoint, Lululemon is a fine company, but they are overvalued and there are better investment opportunities within this industry. I have laid out 2 discount cash flow models below, the first being extremely optimistic and the second being realistic. Both use a 10% discount rate and 6% terminal growth rate.
As you can see from the DCF above, I have been a bit liberal with Lululemon's growth across their top and bottom lines. While my topline falls in line with Lululemon's projection of $4.6 billion of revenue by 2020, I have free cash flow at $437 million for the same period. There are 2 main reasons that this model is optimistic:
1) I used a consistent operating margin of 20%, which is actually higher than their current OM of 16.8%.
2) I used a high revenue growth rate and a 6% terminal growth rate. Assuming they are going to experience the double digit growth rate laid out in this model is pretty optimistic given their 3-year growth rate is 14.6%.
With this most optimistic model, I have Lululemon's equity valued at almost $13.2 billion, which represents a 35% increase from their current market capitalization of $9.8 billion. However, Lululemon's ability to maintain these consistent margins and strong topline growth are, in my opinion, unlikely. Below I have outlined what I believe to be the more realistic DCF for Lululemon.
As you can see, I am not as optimistic across Lululemon's topline as their management. I believe too many factors, including increasing competition, potential fashion trend shift, and inability to broaden their brand presence into the male market are sufficient reasons to believe Lululemon will not reach their $4.6 billion target by 2020. I also have Lululemon's operating margin declining from 19% down to 17%, which is still slightly higher than where they currently sit. I believe that their operating margin see a modest decrease over time in order to maintain double digit revenue growth. With Nike (NYSE:NKE) and Under Armour (NYSE:UA) having more competitive pricing, Lululemon will face more threats to macro-economic factors, and will possibly have to restructure their pricing strategy in order to compete in the male athletic apparel market, which will affect their margins.
With this more realistic model, I have Lululemon's equity valued at $7.9 billion, which represents a premium of 19.4%. With other companies in the athletic apparel industry available to investors, I cannot recommend a long position in Lululemon.
I believe Nike, Under Armour, and Skechers all present better investment opportunities. Nike is the safest play that is not as heavily dependent on the athleisure fashion trend as much as Lululemon is. Nike has shown to dominate the athletic footwear and apparel industry for athletes and not just as a fashion trend. Under Armour is growth play which is growing at an incredible speed and making big investments to move along their lines of athletic apparel and position themselves as a long-lasting dominant brand like that of Nike. And finally, Skechers (NYSE:SKX) is a great value play that has seen very strong recent growth and still trades at a discounted PE compared to its peers.
Lululemon isn't the only company in the athletic apparel industry making some pretty questionable projections. Nike projected to hit $50 billion in sales by 2020, which seems to be a high mark given their current growth rate. Under Armour is also constantly making big projections but also hitting them rather frequently. The difference that I see is that Lululemon doesn't justify their current valuation. I am sure that the company will see some pretty decent growth in their revenue over the next few years, however they are priced far too high for investment right now.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.