Lululemon Athletica (LULU) – A Solid Performance, Is There More Upside?

Jun 11, 2010

Lululemon Athletica (LULU) came to their recent earnings party ready to rock. In a time when you would consider that discount retailers would be better poised to take market share, there are still apparently a few specialty retailers that have what the discriminating shopper wants.

The official company description:

lululemon athletica inc. is a designer and retailer of technical athletic apparel primarily in North America. Its yoga-inspired apparel is marketed under the lululemon athletica brand name. The Company offers a line of apparel and accessories, including fitness pants, shorts, tops and jackets designed for athletic pursuits, such as yoga, running and general fitness. As of January 31, 2010, its branded apparel was principally sold through 124 stores that are primarily located in Canada and the United States. As of January 31, 2010, its retail footprint included 45 stores in Canada, 70 stores in the United States and nine franchise stores in Australia.

Over the past few years, this company has done a terrific job at name recognition and carving out a niche in the fitness apparel market. Analysts have been steadily increasing their target price and on averge44.20, showing an 10% upside from here. (But this is before the usual change in target price that will come within a few days after the earnings report)

Of the 16 analysts that cover the stock : Buys – 6 , Holds – 9, Sells 1

Recent analyst target price changes – post earnings:

Lululemon (LULU) Target Price increased to $47 by Goldman Sachs
Lululemon (LULU) Target Price increased to $43 by Thomas Weisel

During the past year, revenue from their wholesale segment doubled and this is by far their best growth area. In contrast franchises have been stagnating. Still, the core business, the corporate stores have seen in incremental increase each year since 2006. From $65 million to $393 million in fiscal 2010. As the company continues to grow its profitable business sectors, we could see additional growth ahead.

See below for the Horowitz & Company OnePage overview of LULU:
(Click to enlarge)

Commentary from Goldman Sachs:

What’s changed

1Q EPS of $0.27 was above GS/FC $0.23/$0.21 and guidance $0.18-0.21.

FX-neutral comps +35% beat GS/FC +33%/+28% and gross margin meaningfully exceeded our expectations. Mgmt guided 2Q to $0.21-0.23 vs. FC $0.21 and FY2010 to $1.05-1.10 vs. FC $1.10, but it‘s important to note that 1Q results and FY plans include a higher 40% tax rate (up from previous guidance of 35%) reflecting potential liability of excess unremitted Canadian earnings. Excluding the drag from this higher tax rate, mgmt is raising the full year by the 1Q beat plus $0.02.

Guidance is based on 2Q comps in the mid-20% range and FY comps in the mid-teens.
Implications LULU‘s results continue to validate our confidence in LULU‘s substantial growth potential. In addition to the brands growing momentum, we see specific opportunities in a number of areas: (a) Reinvestment in inventory for 2H and better speed with the new DC should reduce notable out-ofstocks; (b) The 44 showrooms opened this year should accelerate brand awareness, resulting in gains in new store productivity, comp and online
sales; (c) The acquisition of the Australian JV allows them to participate in growth there and sets the stage for longer-term international expansion.

Our Buy rating on LULU reflects

(1) Major long-term growth potential from significant productivity gains in existing stores, opening new doors, and growing online. (2) Near-term catalysts in continuing comp strength as brand awareness ramps in young markets. The brand is only 2 years old in its avg US market, and 90% of its US stores are less than 4 years old.

Valuation
Based on 1Q‘s beat, partly offset by higher tax rate, we raise our 2010/2011/2012 EPS to $1.24/1.63/1.99 from $1.20/$1.61/$1.97, and raise our 6-month, multiple-based price target to $47 from $46. Key risks Multiple premium vs. sector; slower productivity ramp than we anticipate.

Most of the revenues come from the stores in Canada, but the growth of the U.S. has been far an away much more powerful. On a year over year basis, LULU increase U.S. revenue by over 70%.

Lululemon Athletica (LULU) earnings notes (Hat tip Briefing.com):

Lululemon Athletica beats by $0.06, beats on revs; guides Q2 EPS in-line, revs above consensus; guides FY11 EPS in-line, revs above consensus.

Reports Q1 (Apr) earnings of $0.27 per share, $0.06 better than the Thomson Reuters consensus of $0.21
Revenues rose 69.3% year/year to $138.3 mln vs the $128.2 mln consensus.
Company issues guidance for Q2, sees EPS of $0.21-0.23 vs. $0.21 Thomson Reuters consensus; sees Q2 revs of $140.0-145.0 mln vs. $132.56 mln Thomson Reuters consensus. Co issues guidance
One of the concerns with LULU’s Q1 report was the full year guidance. However, the “lowered guidance” seems to be entirely due to the co raising its expected tax rate to 40% from 35%.
Company says analysts going forward should assume a 40% tax rate. Of note, it sounds like analysts modeled a 35% tax rate for Q1, but the actual rate was 40%.
Management is looking to bringing down its sourcing from China over the next several years to around 50% from 70%.
Stores are seeing more traffic, stronger conversion rates and stronger average tickets, in that order.
Lulu is building its inventory levels in anticipation of stronger sales, however, more inventory means more markdowns.
During the conference call, when the company was asked about its cash balance – they said it’s a wonderful problem to have.
Men’s business is doing well, up about 40% yr/yr.
Management continues to model 20% operating margin longer term. However, co cautions it is still early in its growth stage, as such, analysts should expect co will reinvest some of that margin in future growth.