FinkAvenue
In July 2020, I concluded that quality prevails in the case of Lululemon Athletica (NASDAQ:LULU) as the company has been doing a lot of things right in recent years, all while the company made an interesting and good acquisition at the time as well. This all sounds great, yet the great operating performance has translated into greater share price performance, with shares trading at 50-60 times normalized earnings at the time, a risky valuation to be either long as the strong operating performance prevented me from getting bearish as well.
Back To 2019
When I looked at Lululemon in the summer of 2020, which was a very strange summer, of course, the basis for the thesis were the 2019 results, a year in which revenues rose 21% to $4.0 billion, all driven by comparable sales growth as operating margins came in at a healthy 22% of sales. These results made that sales essentially doubled from the period 2014/2015, as margins have risen, while the company has furthermore reduced the share count as well.
Shares of Lululemon traded at $312 at the time, as a net cash balance of over a billion worked down to a $300 per share operating asset valuation. This should be seen in the light of a share count of 130 million shares, revealing that Lululemon was valued at $39 billion, a huge valuation at around 10 times sales and around 60 times earnings.
The share price in the low $300s marked all-time highs at the time, as shares of the company traded around $250 ahead of the pandemic, as investors were really upbeat with Lululemon being a great direct-to-consumer play, certainly as consumers might opt for more sports and certainly at home during the pandemic.
This was already seen in the first quarter results that year (a quarter which ended early in May). Even as sales fell 17% to $652 million, the direct-to-consumer segment was responsible for the majority of sales as there was a 68% increase in sales at that segment, although moving intercompany sales hurt margins in a big way with retail operations getting decimated.
In the meantime, the company acquired home fitness innovator MIRROR in a $500 million deal, with live classes and on-demand workouts being perfect for the ecosystem of Lululemon. The deal was really just a rounding error at the time, although it would deplete most of the net cash balances, as the overall valuation was still too demanding for me to get involved, despite absolute world-class operations.
Two Years In The Making
Since I last looked at Lululemon in the summer of 2020, shares have seen quite some volatile movements. Shares kept rallying, although with some volatility, and hit a high of $485 per share in the autumn of 2021. With Lululemon falling victim to a reversal in technology and other highly-valued names, shares are now down to $285 per share. This marks a roughly ten percent decline in sales over a two-year time window, marking a dramatic underperformance versus the market as the company has not lived up to the sky-high expectations and its valuation, of course.
In March of this year, Lululemon posted its results for the fiscal year 2021. The company has seen continued strong demand as revenues rose 42% to $6.3 billion. These are very strong results as the stores have been on fire, with the direct-to-consumer segment share of revenues falling to 44% of sales as stores reopened across the globe. The company has seen a strong margin performance, with adjusted operating margins being up 270 basis points to 22.0% of sales. These adjusted numbers come in close to the GAAP numbers.
The company posted GAAP earnings of $7.49 per share, but commercial traction was evident with the results in the second half of the year being meaningfully stronger than the first half of the year, as adjusted earnings per share came in thirty cents higher. Furthermore, a $1.3 billion net cash position was equal to about $10 per share.
More good news was seen for 2022, a year in which revenues are set to rise to a range of pretty much $7.5-$7.6 billion, representing 20-22% annual growth. Earnings are set to rise at a similar pace, with earnings seen at $9.25 per share, plus or minus ten cents.
In April, the company outlined some great ambitions for the coming years as it set a goal to double revenues again to $12.5 billion by 2026, a huge target which could be achieved by targeting men and growing the international operations. While such targets are typically nice, there is little evidence to back these ambitions up, as we have seen other retailers outline aggressive plans as well, only to miss on them. But then again, I think Lululemon is a different animal here.
Early in June, the company posted the first quarter results which were solid, as first quarter sales were up 32% to $1.6 billion, with growth split between the US and international operations. Growth was split pretty evenly between stores and online operations. Earnings came in at $1.48 per share in a seasonally softer quarter as the company hiked the sales guidance to $7.6-$7.7 billion, with adjusted earnings now seen between $9.35 and $9.50 per share. The company has been buying back some more shares, yet a near $700 million net cash position is still substantial by all means.
Final Thoughts
The fear of the market is simply a cut to the guidance, even as the company hiked the same guidance just a few weeks ago, with the macro picture deteriorating a bit and as inflation and supply chain issues are still making headlines. Trading at $286, the unleveraged assets trade at $280, as earnings power of around $9.50 per share works down to a 30 times earnings multiple.
Comparing this to the summer of 2020, we have seen largely stagnant share price, yet a premium valuation of 50-60 times has fallen to 30 times on the back of great operational performance in terms of earnings, creating valuation multiple contraction from two sides.
Right now, we have to perform a balancing act. The earnings multiple has contracted to 30 times, still a huge multiple as the 3.3% earnings yield has to compete with interest rate investments there, but they do not offer the same kind of growth as Lululemon, of course. The fear is slower spending and competitive pressures from the likes of Nike, adidas and Under Armour. Yet, the strong performance of the businesses is unparalleled, as the 2026 ambitions are quite ambitious by all means.
Amidst all of this, I am warming up a bit to Lululemon, recognizing that quality is never cheap but prevails in the long run, as further dips to the $250 mark or stagnation around this level in the coming months might be used as an entry point here.
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