Why You Should Avoid Lululemon Athletica

| About: Lululemon Athletica (LULU)

Shares of Lululemon Athletica (LULU) have plunged almost 32% from its 52-week high of $81.09 achieved in May. Although the drop has brought the stock valuation to its 52-week low as measured by NTM P/E (see below), I remain bearish on LULU given that its lofty valuations continue offering very little margin of safety. In this article, I will illustrate the rationales supporting my view.

My value analysis includes a set of sportswear retailers as LULU's comparable peers. The estimated stock value is then determined by equally weighting the valuations calculated by four different peer average multiples (EV/Sales, EV/EBITDA, P/E, and P/S).

The following analysis is based on the table shown below:

In comparison of the growth potential, LULU outperforms all of the listed peers. Its 2-year revenue, EBITDA, and EPS CAGRs are substantially higher than the peer group averages.

In terms of profitability and capital return, LULU has also done an excellent job as the company dominates the peer group in all of the measures listed above.

Sportswear retailers generally have very low and even negative FCF margins, but LULU's LTM FCF is exceptionally high at 13.7%. The firm also carries no debt and is able to maintain robust current and quick ratios, reflecting LULU's superior liquidity position.

As such, I agree that LULU stock should deserve a decent valuation premium given its strong growth prospects and financial excellence. But the current valuations still reflect too much market optimism as the current stock price of $55.56 implies a whopping average of 162% premium over its four peer average multiples (see below).

Applying a more reasonable 100% (still quite generous in my opinion) premium, the estimated stock price would easily drop by 23% to $42.82.

I do not deny that LULU stock may still have a short-term bounce as the over-optimism continues hovering around. But over a longer run, the probability of a significant price correction is much higher as the stock price is fragile at the moment given that it is priced for almost zero mistake. For value investors, you would not want to touch this hot stock due to an unfavorable risk/reward profile. There are a lot of other value picks out there in the market that offer a much safer margin, why choose LULU?

P/E chart is sourced from Capital IQ, analysis tables are created by author, and all financial data is sourced from Morningstar and Capital IQ.

Disclosure: I am short LULU.