Narrow-Moat Lululemon Posts Typically Strong Q3 but Some Mildly Concerning Signs; Shares Overvalued

Narrow-moat Lululemon’s 2022 third-quarter results included 22% comparable sales growth and were in line with our lofty expectations. Yet, its shares dropped by a mid-single-digit percentage in Dec. 8 post-market trading, possibly because it did not raise guidance for the holiday season and because its inventories jumped 85% from last year (as was also the case in the prior quarter). While a surge in inventories can imply slowing sales and lead to markdowns and margin degradation, Lululemon’s management expressed the opposite view, arguing that the high inventories will be needed to meet demand. Even so, the firm expects that year-end inventories will be up 60% from last year. For now, given the firm’s momentum and history of full-price sell-through, we are inclined to support management’s argument that the inventory levels are manageable. Indeed, we expect to lift our $229 fair value estimate by a low-single-digit percentage, although we view its shares, at about 35 times 2022 earnings, as overvalued.