Lululemon Is A Stronger Buy After Earnings

Jun.11.12 | About: Lululemon Athletica (LULU)

Late last week, shares of apparel retailer lululemon (NASDAQ:LULU) took a dive after its fiscal first quarter earnings report. Despite beating street estimates handily, guidance was below street expectations, which triggered the stock's decline. However, this is a company that is notorious for giving very conservative guidance. This decline in the stock is a perfect opportunity to pick up some shares.

First Quarter Results

Lululemon reported revenue of $285.7 million, up 53% from the prior year period. This top line number crushed analyst estimates, which stood at just $270.85 million. Earnings per share came in at $0.32 versus last year's $0.23, and beat analyst estimates by two cents.

Those were very good numbers. Now, the company did see a decline in its margins over last year's period, as seen in the following table.

Q1 Margins 2009 2010 2011 2012
Gross 42.88% 53.77% 58.75% 55.05%
Operating 12.06% 23.48% 27.67% 25.57%
Profit 7.98% 14.16% 17.87% 16.33%
Click to enlarge

In the company's 10-Q filing, it explained that the primary reason for the decline in gross margins was due to higher labor and raw material costs. However, it was still up 128 basis points over the 2011 period. Now despite the 370 basis point decline in gross margins, operating margins only declined by 210 basis points. While selling, general, and administrative expenses were up 45% year over year, as a percent of revenue they were down to 29.4% from 31.0% in the prior-year period. That equals the 160 basis point difference between gross and operating margin declines. Net profits margins were down year over year as well, but were still more than 2 full percentage points above 2010 levels, and more than double 2009 levels.

Balance Sheet

The company has one of the best balance sheets around, and continues to show year-over-year improvement. The following table shows three key financial ratios at the end of fiscal Q1 over the past four years.

Financial Ratios 5/3/09 5/2/10 5/1/11 4/29/12
Current Ratio 4.16 5.12 5.93 7.88
Working Capital $86,534 $192,646 $290,998 $487,271
Debt Ratio 19.02% 19.60% 15.02% 12.62%
Click to enlarge

Lululemon has nearly $8 of current assets for every dollar of current liabilities. It will not have any trouble paying the bills. Working capital continues to grow rapidly. The debt (liabilities to assets) ratio is under 13%, showing great improvement in the past two years. The company only has about $1 of total liabilities for every $8 of total assets. You won't find many companies having a better balance sheet.

Now the only blemish on the balance sheet was that inventories rose 67% year over year to nearly $108 million. This seemed to cause some concerns in the marketplace. But before you hit the panic button, remember that we saw a similar concern a few quarters ago. How did it work out? Well, the company had a tremendous following quarter with revenue soaring. Oh, and this quarter they just reported wasn't too shabby either.

Forward Guidance

This seemed to be the main reason the stock took a hit. The company stated that it believed fiscal Q2 revenue would be in a range of $273 million to $278 million, and earnings per share in a range of $0.28 to $0.30. Both numbers were below wall street estimates at the time, which stood at $289.78 million and $0.33, respectively.

Now, if you think this is the reason you should run for the exits, you are sadly mistaken. This company has always provided very conservative guidance, so I wouldn't be worried at all about this guidance. Just look at the following table. I've compiled the guidance given by the company over the past six periods and the actual results.

LULU Revenue Earnings Per Share
Quarter Guidance Actual Guidance Actual
Q4 2010 $210-$215M $245.4M $0.46-$0.48 $0.64*
Q1 2011 $175-$180M $186.8M $0.36-$0.38 $0.46
Q2 2011 $200-$205M $212.3M $0.21-$0.22 $0.26
Q3 2011 $225-$230M $230.2M $0.22-$0.24 $0.27
Q4 2011 $327-$332M $371.5M $0.40-$0.42 $0.51
Q1 2012 $265-$270M $285.7M $0.28-$0.29 $0.32
Click to enlarge

*Adjusted due to one-time tax issue. Unadjusted earnings were $0.76.

Notice a pattern in that table? You should. The company has beat its own revenue and earnings guidance each of the six times, many of them by wide margins. I'm not worried, you shouldn't be either.

Oh, and by the way, the company increased its full-year guidance, which some seemed to have missed. Original revenue guidance was a range of $1.3 to $1.325 billion, and was increased to a new range of $1.32 to $1.34 billion. Earnings per share guidance was originally set at $1.50 to $1.57, and it was increased to $1.55 to $1.60. Those were also below street expectations of $1.35 billion and $1.63, respectively. But again, I'm not worried, it will probably beat in the end.

Comparisons / Industry Peers

Lululemon is an athletic apparel retailer. The two closest competitors would be Nike (NYSE:NKE) and Under Armour (NYSE:UA). Now, for purposes of my argument, I'm also going to compare it with Deckers Outdoor (NYSE:DECK) and Crocs (NASDAQ:CROX). Why, you may ask? Well, Lululemon is considered a high growth consumer/retail name, and those other two are in that same category, in a broad sense.

The first set of comparisons will be on income statement and balance sheet numbers. A couple of things to remember. These companies use slightly different fiscal calendars. Lululemon's year ends in January, Nike's ends in May, and the other three follow a regular calendar. That will make quarter-to-quarter comparisons slightly different, but my main point doesn't matter when it comes to the calendar. Also, some of these names are more summer retailers, while others are winter ones. Let's look at the numbers, and I'll explain why they matter.

Gross Margin 55.05% 45.58% 43.81% 45.99% 53.27%
Operating Margin 25.57% 6.35% 12.98% 4.84% 14.64%
Profit Margin 16.33% 3.81% 9.58% 3.26% 10.43%
Current Ratio 7.88 3.80 3.21 6.81 3.11
Debt Ratio 12.62% 26.75% 31.22% 15.02% 31.53%
Click to enlarge

These numbers are all the last reported quarterly numbers, in terms of margins, and balance-sheet ratios at the end of that quarter. Lululemon has the highest margins, and that stays true over the entire fiscal year. Yes, I know some might bring up that Deckers' Q4 is a very high profit margin quarter, but it also loses money generally in Q2. Over the year, lululemon still beats its margins by a bit. Also, lululemon's balance sheet is much better than any of the others. None of these companies is in any financial difficulty at the moment, so lululemon is just in the best shape currently.


Lululemon has always been criticized for its lofty valuation. That is a fact, and I cannot argue with it. In fact, the table below shows the current price-to-earnings (P/E) and price-to-sales (P/S) ratios for this current fiscal year "CFY" and next fiscal year "NFY".

P/E (CFY) 39.74 43.96 22.04 11.92 11.18
P/E (NFY) 31.14 34.32 18.76 9.87 9.44
P/S (CFY) 6.89 2.98 2.06 1.33 1.26
P/S (NFY) 5.54 2.45 1.88 1.18 1.10
Click to enlarge

Lululemon is more expensive than the others in all categories, except for being cheaper than Under Armour on a price-to-earnings basis. So what are you getting for that higher valuation? Well, as I've detailed already, you are getting higher margins and a cleaner balance sheet. But you also are getting more growth, which I detail in the next table.

Revenues (CFY) 35.2% 22.7% 15.7% 13.3% 17.0%
Revenues (NFY) 23.9% 21.6% 9.7% 12.5% 14.0%
EPS (CFY) 29.4% 27.0% 12.3% -10.7% 18.5%
EPS (NFY) 27.6% 28.1% 17.4% 20.8% 18.4%
Click to enlarge

Lululemon is growing the fastest right now, in terms of both revenue and earnings. Yes, the two-year earnings per share total is greater than Under Armour, despite next year's number being slightly lower. Yes, Deckers is even expected to post a decline in earnings this year. It is going through a number of troubles currently, which I've detailed in the past. Crocs has also struggled lately, and a number of profit warnings in recent years keeps knocking that stock down.

Now yes, the valuation does seem a little high at first glance. But you get what you pay for, and you are getting a top-tier name. Also, the stock has declined from a 52-week high of $81.09, reached in the past two months, to Friday's close of $64.77. That's a decline of 20%, and earnings estimates have not come down at all. That means that the price-to-earnings ratio, based on this year's number, has declined from nearly 50 to just under 40. The price-to-earnings multiple, based on the next fiscal year, has declined from 39 to 31.

Conclusion - Decline Overblown

Thursday's decline in shares of lululemon seems to be a bit of an overreaction. The company posted a great quarter, and has been known for giving incredibly conservative guidance. It has a high margin business for an apparel company and a retailer, and its balance sheet is one of the best around. The valuation is what seems to trip people up, but sometimes you have to pay for best in breed. The stock has come down 20% since its high. The average analyst target is over $78 with a target as high as $100. There is still plenty of upside left with this name.

But the trade on this name depends on your view of the overall markets. If you believe that problems in Europe can be solved and that markets will rally, you should definitely jump on this opportunity. It won't be here for long. But if you think markets are going to go lower, it is possible for this name to trade down to $60, or perhaps lower. In that case, you might want to buy a portion of your position here and buy more lower.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in LULU over the next 72 hours.