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Lululemon Is A Winning Retailer At A Fair Price


-Lululemon has topped estimates for nine consecutive quarters.

-During that stretch, LULU stock has risen more than 260%.

-Lululemon should continue to top estimates for the foreseeable future, mostly because this company is a high-quality leader in a healthy growth industry.

Shares of Lululemon (LULU) popped in mid-June after the athletic apparel brand reported yet another beat-and-raise quarter. This marks the ninth quarter in a row where Lululemon topped both earnings and revenue estimates. During that stretch, LULU stock has risen more than 260%.

This beat-and-raise streak should continue for the foreseeable future, because Lululemon is a high-quality, high-growth athletic apparel brand with lots of runway to keep growing at a robust clip. As this streak continues, LULU stock will similarly continue to rally.

As such, we identify LULU stock as a solid long term holding. The valuation isn't great right now. But, the price is fair, and robust profit growth over the next several years should drive solid share price performance.

Lululemon's first quarter earnings report was really good. Comparable sales in constant currency rose 16%. Revenues rose 22%. The digital business grew at a 35% clip. Gross margins expanded 80 basis points. Operating margins rose 40 basis points. Operating profits rose 23%.

In context, these strong numbers are just more of the same from Lululemon. Throughout 2018, comparable sales growth ran in the high-teens range, revenue growth ran in 20%-plus range, the e-commerce business grew at a 35%-plus clip, gross margins were expanding by 100-plus basis points every quarter, operating margins were running higher, and profit growth was robust.

Under the hood, this strong performance shouldn't be much of a shock. Lululemon is in the right space - the athletic apparel market continues to benefit from athleisure, social workout, and health awareness trends, and is growing at a 7% compounded annual growth rate. In that healthy growth industry, Lululemon has cut out a niche for itself as a high-quality player with strong brand equity. At first, the company just had that reputation in the women's yoga apparel market. But, over the past several years, Lululemon has extended its high-quality, strong brand equity reach into other athletic apparel segments, like the broader women's apparel market, the footwear market, and even the men's market. In doing so, Lululemon has rapidly gained share in the healthy growth athletic apparel market, and produced consistent 20%-plus revenue growth rates.

This trend will continue. First, the run higher in the athletic apparel market is far from over. For the foreseeable future, athletic apparel will remain the choice apparel for young consumers. The rise of photo-sharing and visual-first social media apps has put external aesthetic and image at the forefront of consumer attention. At the same time, consumers are becoming increasingly health conscious (see the plant-based meat trend). Coupling those together, consumers are increasingly wanting to look and feel their best, which leads to a rise in working out, which leads to a rise in athletic apparel sales. It also helps that athletic apparel has rapidly converged with leisure styles, paving the path for athletic apparel to gain more "wardrobe share".

Second, within that athletic apparel market, Lululemon is still a relatively small player with limited reach. On the women's front, Lululemon is still largely known for just yoga apparel. The casual business is growing, but still small relative to Nike (NKE) and Adidas (OTCQX:ADDYY). The footwear business is pretty much nonexistent relative to the big players. Meanwhile, on the men's side, that business is still relatively small, but growing very quickly (26% comparable sales growth last quarter). The international opportunity here is also quite large, since Lululemon's sales outside of North America were just $360 million last year (versus $2.4 billion in the U.S. alone).

Broadly, Lululemon has a tremendous opportunity ahead of it to continue to leverage its high-quality reputation and strong brand equity to successfully expand into new athletic apparel product categories, as well as scale the business globally. This opportunity is very large. Lululemon's annual sales volume is about $3.4 billion. Nike's is up near $40 billion.

Thus, when you zoom out and look at the big picture trends here and the market opportunity and Lululemon's competitive positioning, it becomes fairly clear that Lululemon has a very realistic opportunity to sustain double-digit revenue and profit growth over the next several years. Indeed, the consensus Wall Street estimate calls for high-teens annualized EPS growth over the next several years, versus low-teens annualized EPS growth over at Nike.

To be sure, investors are paying up for that growth. LULU stock trades at 38x forward earnings, versus a 27x forward multiple at NKE. But, if you model things out, today's price tag on LULU stock seems fair.

Lululemon should drive low double-digit annualized revenue growth over the next several years, which on top of gross margin expansion and operating leverage, should produce around mid-teens profit growth. Realistically, $12 in EPS seems doable by fiscal 2025. At that point in time, Lululemon will look a lot like a small Nike, and should therefore trade a similar valuation to NKE stock. NKE stock historically trades around 25x forward earnings. A 25x forward multiple on $12 in 2025 EPS implies a 2024 price target of $300. Discounted back by 10% per year, that equates to a 2019 price target of ~$185, which means today's $175 price tag seems fair.

n sum, when it comes to Lululemon, you have a high-quality, high-growth athletic apparel brand that will continue to report robust growth over the next several years. At the same time, the price tag on the stock seems fair considering all that growth. The combination of a fair price and robust growth should drive healthy share price performance from here, meaning that the bull thesis in LULU stock remains alive and well. Disclosure: I am/we are long LULU, NKE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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