Lululemon (LULU) reported fourth-quarter results March 22 that were so strong that they even exceeded the firm's upwardly-raised earnings guidance issued as recently as January 10. Earnings per share for the period came in at $0.51 versus $0.38 cents a year ago (split adjusted), while same store sales grew by a solid 26%. Though 2012 guidance came in at a range of $1.50 $1.57 per share (below consensus estimates of $1.61 per share), versus $1.27 per share in 2011, we think it simply reflects management's conservative nature and desire to control expectations.
We wrote prior to its earnings release that Lululemon usually exhibits unpredictable, drastic moves, and the move after earnings was no different. After opening below $72, the shares fell slightly, then ended up rallying to close at nearly $76, which was 2.5% above where it closed the previous day. That's a lot of gut-wrenching volatility, and, as we noted previously, traders/speculators would require unrealistic execution with their entry and exit points to assure profitability.
Shares are currently trading at 44 times our 2012 earnings forecast, but while this multiple is certainly lofty, we don't think the company is necessarily overvalued. We use a discounted cash-flow model to arrive at a company's intrinsic value estimate, and we apply margin-of-safety bands around that fair value estimate to determine whether Lululemon is undervalued or overvalued. If the share price falls within this range (which in Lululemon's case it does), we'd consider the firm to be fairly valued. Click here to learn more about DCF analysis.
Further supporting our cash-flow forecasts, we've yet to see any signs of weakness in the underlying business, and we believe the company has yet to near saturation. We think men could continue to flock to Lululemon's excellent product offering and that the company will ride the tailwinds for athletic participation. Its self-ascribed "no-stink" clothing should expand to even more consumers that may be self-conscious of how they broadcast themselves at gyms and yoga studios.
Though many bears may cite low barriers to entry as the primary reason to short Lululemon, we think the business model itself is harder to replicate than they think. For one, the actual quality of the product is fantastic, in our view. We think that Nike (NKE) is one of the few competitors that can create a similar quality product; however, we think it will be hard to replicate Lululemon's aspirational qualities in apparel. We don't view adidas as much of a competitor, and we reiterate our view that Under Armour (UA) doesn't understand the fashion-conscious customer very well.
Additionally, Lululemon's direct-to-consumer, brick-and-mortar store model allows the brand to connect with shoppers better than brands that do not control the experience. Each Lululemon store is unique to its geography, and sales associates are compensated at above-market rates to provide shoppers with a more informational and enthusiastic store atmosphere. This translates into a better shopping experience and repeat customers.
Ultimately, we aren't crazy about the risk/reward of a high-flier like Lululemon right now, but we would get more excited about shares if they were trading in the mid-$40s, which is the low-end of our margin-of-safety band. The shares may hit those levels if investors overreact to weaker gross margins during the first half of the year or shun the stock on weaker same-store-sales performance in the back half of the year due to tougher comparisons. However, as we learned with Chipotle Mexican Grill (CMG) in the portfolio of our Best Ideas Newsletter, it may be best not to bet against a fundamentally-sound company with price-insensitive customers and plenty of room to grow. We remain on the sidelines at this time.