Shares of Lululemon Athletica (LULU) are up almost 50% in the last six weeks. The company had an impressive second quarter and continues to outperform expectations and raise guidance. Rather than fill you in on all the details from the recent quarter, you can read them for yourself in the latest press release. The purpose of this article is to assist current shareholders and prospective shareholders in determining whether or not to sell, hold, or accumulate the shares of Lululemon.
Investors love earnings and this company delivers, growing them at remarkable rates (2008 EPS growth 25%, 2009 EPS growth 48%, 2010 EPS growth 106%, 2011 EPS growth 50%). To start the new fiscal year (beginning January 30th), management gave guidance of full year diluted EPS between $1.50-$1.57 (18%-30% YOY). As of the last quarter that number was raised to $1.76-$1.81 (39%-43% YOY). These earnings don't come cheap, however. In the chart below, you can see shares of Lululemon will cost you $51 per $1 of earnings (left hand scale), compare this to the S&P 500 which costs $14.58 per $1 of earnings (right hand scale). Shares are currently trading at the high end of their historic levels.
The price-to-book ratio for Lululemon has grown rather rapidly as well. With book value per share growing at over 50% per year for the past three years, the company has done a remarkable job adding to shareholders equity. As the chart below depicts, shares currently trade towards the historical high end.
With net profit margins in the high teens, luxury retailers like Lululemon tend to generate a significant amount of cash. A record $444 million of cash is on the balance sheet as of the recent quarter with minimal debt ($1.4 million in an off-balance sheet line of credit). The company is able to expand its operations from operating cash flow rather than leveraging up. The market is well aware of this and as the graph below shows, shares trade at roughly 44x operating cash flow.
While I typically don't like to use the EV/EBITDA multiple for high growth companies like Lululemon, I think the data illustrates an important point. As you can see in the chart below shares currently trade at 30.69x! This is well above the four year average of 18.44x. Note: I factor in non-cancellable future lease payments as debt into this calculation.
Although I do not own shares in Lululemon (nor do I practice yoga), I would not be surprised to see this stock in my portfolio over the next few years. The company operates in a very niche market and its typical consumer, mid-30 year old female, has the budget to afford these high end yoga products. With the growing trend of consumer health, the market for yoga will likely expand for years to come. Competitors like Under Armour (UA) and Nike (NKE) are already attempting to gain market share. CEO Christine Day had a great remark when asked about copycats in the industry:
"In some respects, this is a tremendous compliment, as the saying goes, 'Imitation is the sincerest form of flattery.' However, while others may try to mimic parts of our business, it is impossible to copy a personality."
Before you get caught up in the hype and unbelievable growth story that Lululemon delivers, consider the graphs and charts listed above. If the company can continue to grow at such a rapid pace moving forward then it likely demands these high multiples, and in my opinion, is currently fairly valued. However, looking at chart of the stock's price you can see tremendous volatility, and a pullback appears likely. Given the dramatic rise in short interest over the past few weeks (see chart below), I would strongly recommend patience before entering into new positions or adding to existing positions.