Lululemon's Earnings: Very Well Done

About: Lululemon Athletica Inc. (LULU)
by: D.M. Martins Research

Lululemon delivered another impressive quarter, marked by mid-teen comps and expanding margins.

The company is benefiting from resilient demand for women's tops and bottoms, along with strong growth prospects in menswear, digital sales and international.

LULU is a stock worth giving serious consideration within an otherwise weak apparel retail space.

I challenge the reader to find any softness in Lululemon's (LULU) fiscal 1Q19 results.

After Wednesday's closing bell, the sports apparel vendor and retailer posted its ninth straight all-around beat. Revenues of $782 million topped expectations by a respectable $27 million on a healthy combination of outstanding total comps and inorganic growth driven by new store openings. EPS of $0.74 was also ahead of estimates, rising an impressive 33% YOY.

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Credit: NY Post

Lululemon seems to be faced with an encouraging combination of resilient demand for women's tops and bottoms along with very strong growth prospects in menswear, digital sales and the international business (especially in Asia). Direct to consumer revenues have now surpassed one-fourth of total sales, a positive development given general consumer behavior trends.

See comp chart below. Notice that the metric has been descending progressively over the past few quarters. But I find a 16% read in the most recent period on top of an already strong 19% last year, highly respectable.

Source: DM Martins Research, using data from multiple company reports

I was also impressed to see gross margin expand by 85 bps, driven primarily by lower cost of goods and subdued discount activity - despite higher supply chain costs. Opex as a percentage of revenues increased by about 40 bps. But the management team assured analysts during the earnings call that the trend is likely to reverse to strong SG&A leverage in the back half of the current year. The optimism was reflected in full-year EPS guidance, higher by three cents vs. last quarter's outlook, which I still find a bit too conservative.

See summarized P&L below:

Source: DM Martins Research, using data from company reports

I was also pleased to hear Lululemon's strategy to deal with current trade challenges. Although only 6% of the company's inventory is sourced from China, port capacity could have an adverse impact on the fall collection reaching customers in a timely fashion.

To that effect, the company is planning on hedging the transportation issues by using more air freight. The impact of a handful of cents to full-year EPS does not seem too concerning to me. At least, Lululemon's growth story is less likely to be impacted by supply chain bottlenecks in the next few quarters.

On the stock

Back in August, when I last wrote about LULU, I recognized the company's impressive execution, following an early 2017 that looked concerning for the athleisure company. But I also played contrarian and supported the idea that the stock looked a bit too overpriced at a current-year earnings multiple of 44x that proved to be close to peak valuation levels.

Chart Data by YCharts

Now, I am once again dazzled by the results of fiscal 1Q19 and the outlook for the remainder of the year. Luckily, valuation looks a bit more de-risked at a P/E of 38.5x (still rich for most value investors) and long-term PEG of 2.2x that seems reasonable for a high-quality name. Between current levels and a share price of $220, I see a clear runway ahead.

Sure, LULU's stock has recovered from a very soft 4Q18 and risen 41% YTD already. But I cannot imagine momentum fizzling out in the foreseeable future, following the positive news delivered after the closing bell and the bullish sell-side reports that I believe will start pouring in on Thursday morning.

LULU is, in my opinion, a stock worth giving serious consideration within an otherwise weak apparel retail space.

Disclosure: I/we 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.