Lululemon Earnings: Year Off to Strong Start With No Signs of Slowdown; Valuation Stretched

Lululemon Athletica LULU posted typically stellar results in its first quarter as 24% sales growth soared past our 19% estimate. Moreover, it appears to be untouched by the slowing demand for apparel in North America, reporting low markdown rates and offering solid guidance. We think it is benefiting from the strength of its brand—the source of our narrow moat rating—and its relatively high-income customer base. We expect to lift our $247 fair value estimate by a mid-single-digit percentage. Even so, we view Lululemon shares, up about 13% in postmarket trading, as overpriced. Our concerns stem from the rising competition in activewear, the uncertainty related to international expansion, and the hefty valuation. Even though we forecast Lululemon can achieve 11% annual sales growth and lift operating margin to about 25% from 22% over the next decade, its current P/E of about 30 is high in relation to our projection of midteens annual EPS growth.

Lululemon’s first-quarter sales outperformance was mainly due to its store operations (comparable sales up 13%). The company received a boost from the end of virus-related restrictions in China (12% of the quarter’s sales), where its sales rose 79%. Lululemon has added about 30 stores in China over the past year, bringing its total to about 120, and we forecast it can reach 400 stores within 10 years. However, there is risk to this forecast, given the company’s limited history in the region and rising competition. Lululemon has targeted a fourfold increase in international sales between 2021 and 2026, but we model such sales to roughly triple.

Lululemon’s gross and operating margins of 57.5% and 20.1%, respectively, beat our estimates by 50 and 140 basis points. Lower shipping rates are providing a boost, as they are for others in the industry. The firm has committed to higher marketing spending this year, which we view as a reasonable investment, given its sales momentum.