Lululemon Athletica (LULU, Financial) has been one of the best performers over the last 12 months, delivering a nearly 60% return on investment to shareholders who bought the stock in September last year. However, much of this gain has been lost over the last few days, and now the 12-month gain stands at roughly 26%. As such, shares of Lululemon have dropped by more than 18% over the last 10 days.
The big question though is whether or not Lululemon deserves the treatment it has received from investors in the last few days, following the announcement of its Q2 results, which impressed across most of the performance metrics.
What happened to Lululemon’s Q2 results?
Lululemon’s net revenue for the most recent quarter (ended Aug. 2) was $453 million, a 16% increase compared to what the company posted in the same period last year. The company’s earnings were reported at $47.7 million, representing a slight decline from last year’s $48.7 million.
However, the specialty apparel company’s diluted EPS was 34 cents per share compared to last year’s 33 cents. The company’s performance for the quarter was notably impressive on the topline, beating average analyst estimate of $466 million, but the bottom line was more or less in line with the average estimate of 33 cents per share.
One of the main downsides of Lululemon’s most recent earnings call came in the form of guidance for the Q3 and full year results. For the full year, the company revised upward its initial projection on both earnings and revenue to $1.87 to $1.92 and $2.025 billion to $2.055 billion, respectively. This is up from the previous estimates of $1.86 to $1.91 and $1.97 billion to $2.02 billion. However, analysts had greater hopes on the company’s profitability, expecting EPS of $1.93 for the period.
Furthermore, Lululemon’s guidance for Q3 EPS also came short of what analysts had projected after the company estimated 35 to 37 cents earnings per share, compared to analyst expectation of 43 cents per share.
Based on these numbers, it is quite clear that the company remains optimistic on the topline. However, the bottom line is what caused concern in the market, prompting investors to send the shares of Lululemon crashing by about 16% the following day.
Should investors be this scared?
The massive plunge in the price of Lululemon implies that investors were stunned at the guidance issued by the company on earnings. However, there are a number of reasons that suggest investors should be a little more optimistic than they currently are.
To begin with, the company showed its optimism towards growing revenues over the next few quarters. This is a crucial element for Lululemon, especially given the fact that about a year ago, many had doubts over the company’s long-term future.
This was primarily due to the company’s pricey yoga pants compared to peers in the market, as well as a saturated domestic market in Canada. Nonetheless, Lululemon has proved many doubters wrong over the last couple of months and it is now expanding its stores geographically to new regions, including Europe, Asia and the Middle East.
The company has recently opened stores in Hong Kong, Singapore, Netherlands, Germany, Sweden, France and Switzerland, which will serve as a strong base for expansion. In addition, Lululemon appears well set to explore opportunities in the Middle East after revealing early this year that it has already established concrete plans to open two stores in Dubai by the end of 2015.
In addition, Lululemon is also keen on strengthening its position in ecommerce platforms, and this campaign appears to be headed in the right direction as its ecommerce channels and investments in innovative product lines are well matched.
As such, Lululemon does not deserve the treatment it received following Q2 results. Investors appear to have concentrated on the Q3 and full-year guidance on earnings. However, perhaps investors are forgetting that whatever is affecting the company’s earnings also has to do with adverse currency translation, which is a macro-economic factor.
Therefore, given the company’s 18% plunge (from $65 per share to about $53 per share) Lululemon has just opened a very lucrative window for investors to buy the stock.
What are the key risks?
The first measure of performance for a company like Lululemon would be looking at the potential for growth in the topline.
The company already looks optimistic in that respect, and has already delivered this year so far. There is no reason to think that it won’t deliver in the coming quarters as far as revenue is concerned. At the moment, there are no major risks attached to the company’s revenues potential for the next 12 months.
NOTE: Lululemon’s weakening gross margin
However, when we look at the bottom line, there are a couple of risks, and these are highlighted in the company’s weak margins.
Apart from the effects of currency translations, the company’s margins were largely affected by increased airfreight expenses incurred to counter port delays at the West Coast, as well as the weakening of the Australian and Canadian dollars. Lululemon’s margins were also impacted by occupancy deleverage and higher markdowns.
The company expects airfreight costs, adverse currency translations, and occupancy and depreciation deleverage to continue affecting its margins in the near term, which means that Lululemon investors should be patient with regard to earnings growth.
Conclusion
The bottom line is that Lululemon has experienced an unnecessary treatment following its weak guidance for Q3 and full year 2015. However, the company’s growth campaign looks to be very much on track, which will help in improving the topline.
As for earnings, investors will have to be patient, and this is always the case when analyzing a company’s potential based on growth prospects. Lululemon is not a small company given its market valuation of about $7.4 billion, but still shows that there is a lot of room for growth as per its recent ventures.
In terms of pricing, Lululemon appears slightly expensive compared to peers (P/E ratio of 28x versus 17x for industry), but this can also be interpreted as a better attraction to investors compared to the industry average. Nonetheless, even with its declining margin, its 49% gross margin still tramps the industry average of 42%. Lululemon’s operating margin is also better than industry average at 19% compared to just 5%.
As such, there are a lot of positives to look up to when analyzing Lululemon, which makes it an interesting stock for the next few quarters.
