In September 2019, GuruFocus contributor Mark Yu titled and subtitled an article with these words, “Lululemon Athletica: Next Stop Is the Moon. There is no slowing down the trendy jogging pants retailer.”
That proved to be a prescient forecast, as the Lululemon Athletica Inc. (LULU, Financial) share price shot up from about $193 to just over $470 two years and two months later. That’s a gain of 144%.
However, as the chart shows, the price has since spiraled down to less than $300. What’s more, it appears on the Buffett-Munger Screener list, meaning it has passed quality and value hurdles.
What’s happening here?
For a start, we can look at what’s happening to companies in the same sector. An exchange-traded fund that represents these names is the Consumer Discretionary Select Sector SPDR (XLY). Notice how its profile resembles that of Lululemon, with both beginning to tank in November of last year:
Companies in this sector sell nonessential goods and services, such as electronics, autos and apparel. They are sensitive to drops in the business cycle because consumers often put off or reduce their purchases when economic uncertainties exist.
Like many of its peers and competitors that sell products, it has felt the effects of Covid-19 and supply chain issues. Lululemon has referenced them in its second- and third-quarter results. Still, it has enjoyed sterling returns and strong metrics.
Strategy
In 2019, Lululemon announced a new growth strategy for the following five years. Called the Power of Three, it aims to double men’s and digital revenues, as well as quadrupling international revenues. It also calls for the core women’s business to increase revenue growth in the low double digits annually.
The three tactics underlying the strategy are:
- Product innovation.
- Omni guest experience.
- Market expansion.
So far, the strategy has worked, as shown in this excerpt from its third-quarter infographic:
Regarding product innovation, this retailer of “sweaty pursuits” has just introduced its first line of footwear. Four new women's styles debut on March 22, and men's footwear will be introduced in 2023. The company calls this its "official entrance into the footwear category."
Financial strength
The headline on this table might be that Lululemon has no short or long-term debt. What may look like debt in some spots on the summary page refers to capital lease obligations.
We also see strength in its WACC versus ROIC ratio. The return on invested capital is 32.34%, more than triple the weighted average cost of capital at 9.90%.
It also has an enviable cash flow record, growing an average of 17.72% per year over the past decade:
Profitability
Very few companies receive a full 10 out of 10 score for profitability, and that puts Lululemon in elite company.
On the operating margin metric, it outperforms 94% of its peers and competitors in the retail-cyclical industry. Its net margin is better than 91.48% of them.
Its growth lines also come out well ahead of the industry medians, although its Ebitda and earnings per share are not so far ahead of the field.
Competition and performance
Lululemon has this assessment of its competitive environment in its annual 10-K filing with the SEC:
“Competition in the athletic apparel industry is based principally on brand image and recognition as well as product quality, innovation, style, distribution, and price. We believe that we successfully compete on the basis of our premium brand image and our technical product innovation. We also believe our ability to introduce new product innovations, combine function and fashion, and connect through in-store, online, and community experiences sets us apart from our competition. In addition, we believe our vertical retail distribution strategy and community-based marketing differentiates us further, allowing us to more effectively control our brand image and connect with our guest.”
Named competitors in its 10-K include Nike Inc. (NKE, Financial), adidas AG (XTER:ADS, Financial), Under Armour. Inc (UAA, Financial), Columbia Sportswear Co. (COLM, Financial), The Gap Inc. (GPS, Financial), Victoria's Secret & Co. and Urban Outfitters Inc. (URBN, Financial).
The 10-K also offers this comparative performance chart for the five years ending Jan.31, 2021.
Dividends and share repurchases
Lululemon does not pay a dividend, but it did buy back shares for six years before Covid-19 hit.
Valuation
As noted above, the share price has slumped since last November, raising the possibility Lululemon may now be undervalued.
That’s backed up by the GF Value Line chart.
However, the company’s overall valuation ranking is low:
We see multiple red and orange bars when comparing it with the industry. Its price-earnings ratio, for example, stands at 43.78, much higher than the industry median of 16.03. Similarly, Lululemon has a PEG ratio of 1.9 compared to the industry median of 1.16. At the same time, note that its current valuation is generally better than it has been in the past, as evidenced by the green and yellow bars.
When we look at the discounted cash flow calculator, there is a significant difference when using the 10-year or five-year earnings per share growth rate as an input. First, using 10 years, we get an overvalued result:
But the growth of earnings accelerated over the past five years, providing an undervalued result from the DCF calculator:
Obviously, investors will have to sort out the mixed messages from valuation metrics. Given that the stock has plunged 42.95%, I’m inclined to view it as undervalued, despite the price-earnings and PEG ratios.
Gurus
It seems the investing legends were trying to capture some of those big capital gains in the final quarter of the year, with five of them buying and two selling:
Eight gurus held positions in Lululemon at year’s end 2021. The three largest stakes belonged to:
- Spiros Segalas (Trades, Portfolio) of the Harbor Capital Appreciation Fund; he held 1,201,574 shares, good for a 0.93% stake in Lululemon and representing 1.33% of his fund.
- Jim Simons (Trades, Portfolio)' Renaissance Technologies owned 225,093 shares.
- Ray Dalio (Trades, Portfolio)'s Bridgewater Associates held 78,204 shares, after a reduction of 40%.
Conclusion
Lululemon Athletica deserves the attention of value investors, and of growth investors who want to enter at a discounted price. It’s a strong company, with no debt on its balance sheet and a price that has dropped considerably.
Given its strong revenue and earnings growth, both in the middle-teens range, it will be a matter of “when” and not “if” the share price gets back on track. The current inflation and supply chain issues may be continuing headwinds, but Lululemon has the initiatives and momentum to overcome them.
Of course, the price may drop even further, with even better rewards for investors prepared to wait and watch.
