When looking at Lululemon's story there are some very clear bright-spots. For starters, the company reported strong third quarter results with revenues coming at $380 million, retail same-store-sales (the most relevant figure for retailers) growing by 5% and total operating margins coming at 24.3%, well ahead of consensus estimates. Besides, the CEO announcement came sooner than expected and Potdevin's fitness executive experience at Burton Snowboards and his global expansion efforts at TOMS are nothing but good news for Lululemon's investors.
Overall, retail analysts were way too optimistic regarding Lululemon's growth potential. Credit Suisse, for example, expected Lululemon to be able to grow its same-store-sales by 9% year over year and its square footage by 15% annually. Those unrealistic figures had provided 20% year-over-year revenue growth estimates. The bank's analysts are now expecting the company to grow its same-store-sales at low single-digit rates and it has trimmed its 2017 EPS estimates by 26% to $3.69.
All the above being said, it's important to stress one essential fact: Lululemon is still growing fast and very profitably. The problem was to be found in expectations. They just were too high. As in most of life matters, in finance also happiness equals reality minus expectations.
As I just mentioned, happiness — and investment results — equals reality minus expectations and, according to the company's valuation, overall expectations are still too high in Lululemon's case. Despite being down by 21% year to date Lululemon trades at 21 times 2014 EV/EBITDA and 30 times earnings, which is well ahead of its peer average.
For example, American Eagle Outfitters (AEO) trades at 16 times 2014 earnings while The GAP (GPS), which is growing earnings at an 18% year-over-year pace, sells for 14.2 times 2014 earnings. Hence, I strongly believe that expectations about Lululemon's future growth are still too high. Investment history can provide multiple cases that appear to resemble Lululemon's case. Let's just think of Crocs (CROX). Back in June 2011, Crocs' share price was $25 and its P/E multiple was around 27 times. Right now, the company's shares are worth $13 and the company trades at a 15.5 times P/E.
For the time being, I think Lululemon is a clear short, even when Ron Baron is still long on the company's shares. At a price below $25 (which represents a 56% discount to the current price level), I believe the company does have a future and will be able to grow its top line fast. I would be long Lululemon but not at any price above such a level. We shall have to wait and see.