When I see a stock (this isn't a small cap bio-tech) fall 20% or more in a single trading session, my ears perk up a bit. Typically, I assume that there is a good bit of emotion involved in selloffs of those fashions, and that's where I like to step in and attempt to place a contrarian bet to make some money. It doesn't always work; when you buy into weakness like this, you risk slicing your hands on the proverbial falling knife. That said, oftentimes, the market quickly realizes its folly and re-rates the stock. I like to think of myself as a long-term investor, though I don't mind taking a risk attempting to trade the bounce on one of these drastic moves so long as I know I wouldn't mind holding onto shares of a given company for a while, should my intuition prove itself to be wrong. Today, I wrestled with this situation regarding Lululemon (NASDAQ:LULU) stock, as it sold off precipitously after giving guidance that disappointed the market.
Although the vast majority of the companies that I own are of the large cap, low beta, conservative, dividend growth variety, I like to follow high growth opportunities like LULU for the ancillary growth basket that I've created within my DGI portfolio. I end up writing about these more speculative, high flying bets more so than I do my DGI holdings it seems, though that's probably the way that I'd like for it to be; if I'm not writing about my DGI holdings, it means they're doing exactly what I want them to do: plug along, slow and steady within an acceptable value range, contributing to my income stream with predictable, annually increasing dividends. Thankfully, I haven't had to write about dividend cuts or massive selloffs like this regarding long-term holdings. Now, I just have to figure out if LULU's long-term growth trend remains intact, or if the stock still has more room to fall, making a purchase in the $50 area a mistake.
So, what happened to cause a 23% selloff in LULU shares?
The company missed Q4 earnings estimates by just a penny and actually beat sales estimates, posting 12.2% y/y growth; however, LULU's guidance was disappointing and makes it appear unlikely that ambitious 2020 growth targets will be met.
LULU's CEO Laurent Potdevin was on Mad Money tonight with Jim Cramer. Here's a link with some of the interview's highlights. One reason that I didn't buy shares during today's trading session was because I was looking forward to hearing this interview. Sometimes, I admit that Jim is pretty buddy-buddy with executives when they come on air with him to do interviews, and there are few meaningful takeaways; though sometimes I think he does a pretty good job of attempting to get answers on touchy issues and/or clarification on points brought up in conference calls. I don't think the Mad Money interview was particularly groundbreaking, though I was impressive with Potdevin's apparent confidence for LULU moving forward, especially with regard to 2017.
Potdevin said two things that really stood out to me. One, he made it clear that he was very excited about the future of his company, saying, "I'm excited about 2017 in a way that I haven't been excited so far." Potdevin has been at the helm at LULU since January 2014 (a period of time that encompasses a strong stock rally), so taking the man at his word, this appears to be a strong statement. Potdevin highlighted the company's global brand campaign that it plans to embark upon in 2017, which could potentially return LULU to growth, and quickly, as eyeballs on the company's products should increase drastically. He sees a lot of opportunities internationally, especially in China, where he said his company was "on fire."
He also mentioned that LULU would be putting its money where its mouth was by buying back as much stock as it could within the limits of its current buyback authorization. In December of 2016, LULU's board of directors approved a stock repurchase program of up to $100m. LULU's current market cap is $7b (down from $9b a day ago), meaning that this authorization represents ~1.4% of the market cap. This isn't a big dent to make regarding retired shares, though LULU only generated $155m of free cash flow in 2016, so I suppose management is doing about the best job that it could in this regard.
I'll be interested to see if the authorization is increased should weakness persist, or if we see an uptick of insider buying moving forward. In the end, confidence is confidence, and I'm happy to hear that management plans to buy back shares at these depressed prices.
While I don't necessarily share the same level of confidence that Potdevin expressed to Cramer, I will admit that I didn't think the quarter was all that bad, and I agree that LULU has potential to do quite well in 2017 and beyond.
Comparable store sales rose 8% in Q4; this is a solid comp, much higher than the Street's 5.3% estimate.
I was impressed to see that women's bottoms posted a 14% comp over the prior year's Q4, which was no slouch. The Bra category (which combines with bottoms to form this company's bread and butter product offerings) also posted double-digit comps at 10%. Maybe even more impressive was the 20% comp that the men's business produced in the most recent quarter. The men's business is obviously being judged against a much lower bar than women's bottoms or bras, though it remains an integral part of LULU's long-term growth story. If men's and children's can catch up to the success that women's apparel has had for LULU, we'll be talking about a company with a much larger market cap than the $7b where it sits today.
Any investment in retail appears to be a risky one at the moment. Just about all of the stocks in this space have been beaten down over recent months with no apparent end in sight. Consumer confidence is up, but spending seems to be directed elsewhere. I do like LULU more so than I do others in the retail space because of its rather unique physical footprint. I believe that LULU has done a great job with regard to the locations of its physical stores, in high quality malls and/or near affluent populations, who are likely to be spending $100 or more on a single piece of apparel. These blue chip type locations are at much less of a threat to the e-commerce headwind that lessor malls face.
In Potdevin's interview with Cramer, he mentioned that the company plans on expanding its square footage by 12% in 2017. Management expects to see 28 new store openings and 12 optimizations, or expansions, of a handful of its more productive active locations domestically with another 15 company operated stores slated to open in international markets during the coming year. This optimization is a good plan, in my opinion. Potdevin mentioned the success of this strategy in the company's Mall of America store in the Cramer interview. By focusing on proven locations the company is able more accurately predict ROI. This is why Potdevin was confident in saying that LULU has a light, yet highly productive physical footprint, and I believe that this company's plan will enable it to do well (or at least, better than its competitors) moving forward, even in the physical space, which has been covered, in general, by a dark cloud for a year or so now.
As previously mentioned, much of the sell-off appears to be related to the company's guidance and the fact that it appears that LULU will now miss its 2020 growth target of $4b in sales. Management, on the other hand, appeared to be confident in its ability to hit these goals, highlighting the plan once again in the Q4 CC.
Management was steadfast in its plan to produce $4b in sales by 2020 (~$3b women's combined with ~$1b men's). I've seen that some analysts don't feel as though this is a realistic goal anymore due to 2017 guidance, though I do think that Potdevin and crew have earned a bit of respect and trust over the years and I am happy to continue to use that $4b sales figure in my long-term modeling.
What's more, LULU plans to grow earnings at a pace that is at least in line with sales (it achieved this in Q4) meaning that if it is able to double the top line to $4b by 2020, the bottom line will quickly grow into today's premium multiple. Assuming that LULU is able to hit its earnings target, we're talking ~$3.89/share by 2020. This represents a 13.22x multiple on today's $50 share price. However, at this point, I worry that that assumption is a big one.
LULU grew its adjusted EPS by 15% in 2016, though it will need to increase that figure over the next several years if it is going to meet its ambitious 2020 goals. The company's recent guidance only calls for ~7.5% EPS growth in 2017 to $2.26-$2.36 (this 7.5% growth figure is based off of the guidance's mid range). LULU has a history of low guidance, so I wouldn't be surprised to see it beat this potentially sandbagged figure, though it would have to by a wide margin to stay on track for the 2020 double.
Sales are expected to grow nicely in 2017, with the midpoint of the $2.5-$2.6b representing ~25% growth over 2016's total revenues. This growth is nothing to scoff at; it's the primary reason that I'm even considering an investment in LULU shares.
Margins are expected to remain intact throughout the coming year. I've remained impressed with LULU's ability to generate gross margins in the low 50s, though I worry that competition and potential pricing pressures could eventually hurt these figures. Margin compression hasn't happened yet for LULU and management seems to be confident that it won't, though I'm not so sure, so I make sure to factor this into my investment thesis when trying to determine fair value as a potential risk moving forward. Management also guided for SG&A expenses to be flat in 2017, though I fear that these could rise as well due to new stores and optimization plans.
Ultimately, any investment in LULU remains a highly speculative one due to the growth necessary for the current fundamental multiples to make sense. That being said, LULU is much cheaper now at $50 than it was a couple of days ago at $66.
All in all, I think LULU is a wonderful company. The brand name is valuable and carries a premium reputation with consumers. I like the company's real estate strategy, and I believe its digital sales will continue to grow as well. The company has proven itself to be very innovative with its fabrics and designs, and while competition is entering from all angles, I expect that Potdevin is right in saying that LULU remains a leader in the athleisure space.
In the past, I've bought two other apparel companies, thinking that their designs, fabrics, and technologies were top notch, which would enable them to continue to grow market share and grow sales moving forward. One of these purchases has turned out to be a good one: Nike (NYSE:NKE). However, the other is quite possibly the worst investment decision I've ever made: Under Armour (NYSE:UAA). I'm severely underweight on my UAA position. I put my trust in Kevin Plank and his vision for the company just before growth began to slow. I bought shares on what appeared to be significant weakness, though as it turns out, the weakness that I saw paled in comparison to the declines to come. Once growth begins to slow in a highly-priced company like UAA or LULU, the market's reaction is typically a drastic one. This is a shoot first, ask questions later sort of mentality, with the rationality of these drastic moves only able to be proven by future growth (or the lack thereof).
So, right now, looking at LULU, I'm asking myself if I wanted to potentially make another Under Armour-like mistake in the high growth apparel industry? It turns out that at $50, I didn't. I decided to wait and see where the stock heads over the coming days. If LULU continues to sink into the mid-lower $40s, I will have to re-examine this decision because at ~18x forward earnings, I think the quality of this company makes it an intriguing opportunity, even if management fails to hit its ambitious 2020 growth figures. Right now, my PT is $42. I don't know if we'll get there or not, but if we do, I may be adding LULU to my growth basket.
Disclosure: I am/we are long NKE, UAA.
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.