While Nike (NKE, Financial) is often considered the king of sports apparel, a relatively new and smaller competitor called Lululemon Athletica (LULU, Financial) has proven to be a superior investment since its IPO in 2007. Lululemon often gets overshadowed by its larger competitor in the news, but as its stock performance has shown, overlooking Lululemon in favor of Nike may be a mistake for investors.
Considering its history of acquiring market share and achieving consistent profit growth, I believe Lululemon shows great potential as an investment opportunity. This article will examine the favorable market trends driving the company's positive fundamentals and explain how its business model capitalizes on them to the fullest extent. Even though Lululemon's stock is trading at a premium, in light of its recent performance I still believe the stock has potential for long-term growth, though value investors may want to steer clear for now.
Thriving direct-to-consumer sales
Lululemon has implemented a direct-to-consumer business model that has enabled the company to take ownership of most of its sales channels. In the fourth quarter, brick-and-mortar stores accounted for $1.1 billion in sales, reflecting a 15% year-over-year increase.
Meanwhile, e-commerce sales constituted almost 52% of total revenue, with $1.4 billion in sales, representing a 37% year-over-year increase. Lululemon's wholesale revenue accounted for only 8% of its total revenue, with over 90% of sales made directly to consumers through company-owned stores or online.
Control over distribution has significantly affected the company's ability to earn higher profit margins by eliminating intermediaries. The growth of e-commerce sales has also been a boon for Lululemon, allowing it to thrive during a difficult period. Beyond simply supporting the company's online business, the pandemic accelerated Lululemon's progress towards its 2023 objective of doubling its e-commerce business, reaching this milestone three years ahead of schedule.
Taking market share in a competitive space
Lululemon's exceptional progress so far is proof of its immense growth potential in the years to come. The global activewear market is projected to experience substantial growth between 2021 and 2028, as per Statista. As of 2022, the size of the worldwide sportswear market was approximately $319.4 billion according to Statista, and it is forecasted to surge past $450 billion by 2028. Despite Lululemon's significant rise so far, there is still plenty of room for growth.
One of the key factors that has enabled Lululemon to grab market share is its distribution control. Its tight grip over its distribution channels has helped the company maintain a strong hold over its branding, leading to increased customer share of mind. Lululemon gained 2.3% of market share in the U.S. during the fourth quarter of 2022, despite a 5% decline in revenue for the sports-apparel category. This decline may indicate customers are turning to premium brands like Lululemon rather than weaker competitors.
Lululemon's innovative business model is another factor that has contributed to its growth. The company is known for its unique customer experience, including a personalized shopping approach, high-quality products and exceptional customer service. This has helped Lululemon foster a loyal customer base and establish a strong brand image. Lululemon's capability to adjust to shifting market trends has kept the company ahead of the curve.
Lululemon's growth has also been significantly driven by its expansion into new markets, particularly in Asia and Europe. The company has been gradually increasing its presence in international markets. This has helped Lululemon tap into new customer bases and diversify its revenue streams.
Why profits could keep growing
When comparing Lululemon to Nike, it is clear that Lululemon has outperformed Nike in terms of several key metrics. Over the past decade, Lululemon has grown sales by an average of almost 20% annually. This rate is significantly higher than Nike's average revenue growth rate of 8.7% per year during the same period. In fact, during the last five-year period, Lululemon's average revenue per share growth rate was an impressive 25.80% per year, compared to Nike's 7.30% per year.
This trend is also reflected in Lululemon's earnings per share growth rates, consistently outperforming Nike's over the past decade. During the past three years, Lululemon's average EPS without NRI growth rate was 10.70%, while Nike's was 14.60%. Over the past five years, Lululemon's average EPS without NRI Growth Rate was 27.1% per year compared to Nike's 15% per year. Over the past 10 years, Lululemon's average EPS without NRI growth rate was 17% per year, while Nike's was only 9.3% per year.
The past doesn't guarantee future results, but considering that Nike's market cap is still more than four times that of Lululemon, I find it easy to be optimistic on Lululemon's growth runway.
Valuation is a sore spot
Lululemon's fiscal fourth-quarter earnings report showcased impressive revenue and earnings growth, with revenue rising by 30.3% to $2.77 billion and earnings per share coming in at $4.40, which exceeded expectations and drove a 13% jump in the share price. Total comparable sales rose by 27%, with comparable store sales up by 15% and direct-to-consumer net revenue increasing by 37%. Although inventories increased by 50% from the same period in 2021, this was still below the 85% surge observed in the third fiscal quarter.
Chief financial officer Meghan Frank expressed confidence in the company's performance, stating that it remained balanced across product categories, channels and regions. Lululemon is optimistic about delivering sustained growth and long-term value for stakeholders in the future, with anticipated fiscal 2023 EPS of $11.50 to $11.72 and sales between $9.3 billion and $9.41 billion, which is higher than analysts' expectations.
Despite Lululemon's strong performance, its shares are now considered overvalued, with a price-earnings ratio of 54.54. This valuation is even higher than Nike's price-earnings ratio of 34.65.
Although there are indications that the cycle of interest rate hikes is ending, there are still concerns about the state of the economy. Paying a premium under these circumstances may not be a wise choice. Despite the strong performance and growth prospects of Lululemon, investors should exercise caution and consider the company's valuation before making investment decisions.
Takeaway
Lululemon has experienced impressive revenue and earnings growth over the past decade, outpacing its main competitor, Nike. However, the stock's valuation remains stretched even after the Covid market bubble popped. Thus, for value-minded investors, the current valuation may be too high.
