Lululemon Earnings Must Justify Its Valuation

| About: Lululemon Athletica (LULU)

When looking at high growth companies that carry lofty valuations, these names are usually held to a higher standard when it comes to earnings reports. That is especially true when it comes to athletic apparel maker lululemon (NASDAQ:LULU), which is scheduled to report earnings at the end of next week. The Canadian athletic maker is known for its yoga and other fitness products, and has been one of the best growth stories over the past few years. But with that high growth has come a high valuation, which has scared away some investors. I think that is a mistake. Also, the company is known for providing very conservative guidance each quarter, which it usually then beats handily. But when investors see guidance that is a bit below current street expectations, shares tend to pull back. When lululemon reports next week, investors will probably focus on the guidance, but it is the company's earnings that really will justify this high valuation.

When the company reported first quarter results, shares fell because guidance was below analyst expectations. The company guided Q2 revenues in a range of $273 million to $278 million, and earnings per share of $0.28 to $0.30. Both numbers were below analyst estimates at the time, which stood at $289.78 million and $0.33, respectively.

But this company is known for providing very low guidance, and then beating it when it reports. Just look at the table below, which shows their given guidance and actual results over the past 6 quarters.

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

Over the past six quarters, lululemon has beat its revenue guidance midpoint by an average of 7.72%. Now, if we take the midpoint of the guidance above, $275.5 million, and use that 6 quarter average, you can estimate revenues for this quarter just under $297 million. That number would be well above the $282.26 million the street is currently expecting, and still fairly well above the near $290 million the street was looking for going into the Q1 report.

On an earnings per share front, the company has crushed expectations by an average of 22.58% over the six quarter period (using the unadjusted number for Q4 2010). If you apply that to the midpoint of $0.29 in their guidance, you are looking at $0.355. Again, that number would be a bit ahead of the previous analyst estimates, and well ahead of the $0.31 currently expected.

So when the company reports next Friday, do not be surprised if they beat, and beat big. But don't forget, guidance is likely to be less than current expectations for the next fiscal quarter, Q3, which ends in October. Current expectations call for revenues of $300 million and earnings per share of $0.33, so don't be surprised if they give guidance somewhere around $290 million and $0.31 per share.

Now, when it comes to the full year guidance, lululemon guided to a range of $1.32 billion to $1.34 billion, and earnings per share guidance of $1.55 to $1.60. Both numbers are currently below street expectations of $1.35 billion and $1.62, respectively, but the company raised their guidance after Q1. With another strong quarter, it is likely that they could raise the full year forecast again.

But before I get into a true discussion about valuation, I want to bring up the potential growth prospects of this name versus some other names in the space. For this argument, I am looking at names that broadly represent the athletic apparel and accessories sector. For that reason, I will compare lululemon against Nike (NYSE:NKE), Under Armour (NYSE:UA), Deckers Outdoor (NASDAQ:DECK), and Columbia Sportswear (NASDAQ:COLM). In the following table, I will provide the current analyst growth estimates for each, regarding their current fiscal years (current year) and next fiscal year (next year). As a side note, lululemon's current fiscal year ends in January of 2013, Nike's current fiscal year ends in May 2013, and all other names use calendar years.

As you can see, lululemon provides the most revenue growth in this space, and is comparable to Under Armour for the most earnings growth over the two year period. I know that the other three names don't provide as much growth, but I'm using them as a point of reference for when we get to the valuation argument.

Now let's look at valuation. The following table shows the price to earnings ratios for each company, in terms of both this year's and next year's expected earnings.

At first glance, you might be shocked at what you see. The high P/E numbers for lululemon and Under Armour might cause you pause. But here's some things to consider. First, these two names are growing both revenues and earnings much faster than each of these other names. Second, Deckers is going through some problems that will last a year or two, and that is why its valuation, which appears low, is currently justifiable.

I think your main takeaway here should be that lululemon's valuation is quite fair, and maybe even a bit undervalued. The valuation above is based on current expectations for $1.62 in earnings, and if they beat like they normally have, I wouldn't think that $1.65 to $1.70 or higher is out of the question this year. If that happens, I would think that $2.25 next year could be possible as well. If you apply a 35-40 P/E based on that $2.25, you are looking at a range of $80 to $90 for next year. That's plenty of upside from current levels, and fits in with the average and median analyst price targets of $80 and $83, respectively.

The main lesson here is that investors need to be comfortable with lululemon's earnings to justify investing at these levels. After last quarter's results, the "disappointing" guidance sent shares from $70 to $64. I said that it was a good possibility that shares would fall below $60, and they fell to approximately $52. I mentioned buying under $60 would be a good idea, buying as it went lower, and that turned out to be a prudent decision, as of right now with shares above $65.50. Now, I'm not going to recommend any trades through earnings, because we could get a good report with low guidance, which will probably knock the stock down again. But as long as lululemon's earnings remain strong, this is a name to be in for the long run.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.