Lululemon: Does Recent Pullback Represent A Buying Opportunity?

After a spectacular run, shares of Lululemon Athletica Inc. (LULU) have fallen roughly 26% since hitting a high of US$58 on October 22. So is it time to jump back in? Is it still trading above underlying fundamentals like some analysts suggested just weeks ago?

While the stock is still trading at 81 times First Call consensus 2008 earnings, UBS analyst Michelle Tan thinks Lululemon will beat consensus earnings per share estimates over the next year, which should allow it to grow into a price-to-earnings multiple of 35 to 45 times. This would be more consistent with other early stage growth companies like Starbucks Corp. (SBUX) back in the early 1990s, and names like Under Armour Inc. (UA) and Google Inc. (GOOG) today, she told clients in a note.

Ms. Fan upgraded Lululemon to “neutral” from “sell” on valuation, while her price target remains at US$46.

She expects more strength when the yoga apparel retailer reports third quarter results sometime in the next month. She also sees momentum continuing for the Vancouver-based company through the fourth quarter given strength in the Canadian dollar, its immature store base, and the addition of stores in places like New York and Beverly Hills.

“While LULU is a highly differentiated concept with, we believe, a lot of growth potential, we do not believe it will be the next mega brand, as it does not have the mass marketing/wholesale distribution of Under Armour or Nike (NKE),” Ms. Fan wrote in a note. “Also, rapid store roll-out and the Canada to U.S. transition add medium term risk.”

Blackmont Capital analyst Barbara Gray explains the recent dip for Lululemon shares as being in sympathy with Crocx (CROX) and Under Armour, which have fallen 44% and 22%, respectively, during the same period due to concerns about high inventories and insider selling.

Lululemon’s decline is strictly a reversal in trading momentum given that it had a lack of inventory, not an excess, which was an issue in the second quarter, and insider selling does not pose a risk, Ms. Gray said in a note.

She maintained a “hold” rating and US$41.50 price target on the stock, saying a pullback under US$40 per share or signs of improving fundamentals would be a good time to buy.