Targeting $70 For Lululemon

| About: Lululemon Athletica (LULU)

lululemon athletica inc. (NASDAQ:LULU) was in the red by nearly 9% Thursday, because the company produced a softer operating outlook than analysts foresaw and investors had hoped for. After analyzing the situation, it appears there was some misunderstanding between the company and the analytical community. Either that, or corporate management is simply putting a positive spin on its results.

In any event, I believe a conservative valuation, applying a forward P/E and PEG ratio of 27X and 1.3X my conservative FY 14 EPS estimate of $2.00, offers prospective investors an opportunity for a 9% return over the coming year to my target of $70. As an analyst, I would attribute a hold rating to a stock offering a return so near the historical annual return of the S&P 500 Index. That said, the conservative nature of my assumptions should offer a margin of safety and opportunity for upside.

LULU's first quarter earnings report showed strong revenue growth of 53% on stellar comparable store sales growth of 25% (on a constant dollar basis). However, LULU gave ground on gross margin, which was attributed to better inventory management. Some of the ground was recovered on SG&A leverage, which will unfortunately be used up in Q1 according to management discussion on the conference call. Still, LULU produced earnings per share growth of 39%. LULU's earnings per share of $0.32 last quarter exceeded analysts' forecasts for $0.30.

However, the company disappointed the Street when it set forward guidance short of analysts' views. LULU set its Q2 EPS forecast for $0.28 to $0.30, versus the analysts' consensus for $0.33. Its revenue forecast for the quarter, which was set for $273 million to $278 million, likewise disappointed the Street, which was looking for $289 million. The company attributed some of the trouble to currency expectations for the Canadian dollar, and to its inventory difference.

It would seem analysts may have misunderstood the company's guidance in the past, as most of its SG&A gains displayed Thursday were lapped in Q1 and won't come to play moving forward. Also, the inventory issue may have been misunderstood by analysts, and the currency expectation could be different as well. In my view, investors might have been served better by their analysts and brokers here.

Once the adjustment is made to gross margin on the inventory management change (perhaps costing the next three quarters), the same old stellar growth should apply to results. Otherwise, the company could be putting a positive spin to their numbers. In any event, while valued at 42X EPS, there's no slack for missteps. Whatever the problem, the shares were obviously valued on a different expectation and have been discounted appropriately Thursday.

There's some speculation regarding the impact of potentially tighter consumer spending should the economy soften, and how that might impact stores offering products to the middle class and upper middle class. Names like Talbots (NYSE:TLB), Tiffany (NYSE:TIF), Saks (NYSE:SKS) and Nordstrom (NYSE:JWN) have had a tough go of late, probably for this reason. Meanwhile, discount dealers like Dollar Tree (NASDAQ:DLTR), Amazon.com (NASDAQ:AMZN), Wal-Mart (NYSE:WMT) and Costco (NASDAQ:COST), which I recently discussed, have followed a different path. Still, LULU has taken a nice haircut now, and is still riding a popular fad that seems to have much life ahead of it.

Assuming the company reaches the top end of its full-year EPS guidance of $1.60 (I think it can), then it is valued at 40X that figure today. The forward 5-year growth forecast for LULU is 27%, giving it a PEG ratio of 1.5X. It's probably that high because of its historical growth track record, which is amazing. Still, I could not justify a current PEG ratio of over 1.3X, while also allowing for some margin of safety. This prices the stock at $56 currently. That's 12.3% less than its current market value of almost $64.

However, assuming the company can earn $2.00 conservatively in FY 14 (Jan.) - analysts see $2.08 - then my rough and conservative one-year target price for LULU is $70, which is 9.6% above the current stock price. Therefore, and excluding all other reasons to trade the shares (tax etc.), I would recommend current long-term holders of LULU continue to hold the stock. Prospective investors would want to compare this 9% conservative appreciation expectation with their required return and other investment options, and decide what to do with LULU from there.

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