Lululemon Stock: Does High Growth Justify Its Valuation?

I am neutral on Lululemon Athletica (LULU) as its strong competitive positioning, impressive growth track record, and outlook are offset by a relatively uninspiring valuation and inflationary and recessionary concerns in its future.

LULU is an athletic apparel and accessory designer, distributor, and retailer with two main business segments: Company-Operated Stores and Direct to Consumer.

Its Company-Operated Stores include outlets and warehouse sales locations, and it also operates an interactive workout platform, a network of wholesale accounts at yoga studios, health clubs, and fitness centers, as well as a meaningful e-commerce business via its website and mobile app. The company currently operates in several countries across North America, Europe, East Asia, and Oceania.

Ambitious Growth Goals

LULU stock has been powered in the past by its strong execution of ambitious growth goals, and it has its sights set on more of the same in the future. Since going public back in 2007, the company has compounded earnings per share at an exceptional 38.3% annualized rate, making it a stellar growth stock.

Over the next half-decade, the company is unlikely to replicate its past success, but it is still expected by analysts to compound earnings per share at an impressive 16.4% annualized rate. A big force behind this growth is likely to be its recently unveiled “Power of Three x2” long-range growth plan.

This plan – if executed successfully – will double the company’s e-commerce and men’s sales while quadrupling international sales over the next half-decade. This should enable it to reach $12.5 billion in total revenue by 2026, reflecting a doubling over the half-decade period from 2021.

It would also likely mean that LULU will grow its earnings per share at a much brisker pace than forecast by analysts, as the consensus analyst estimate for revenue in 2026 is only $11.2 billion.

In fact, it expects a 15% revenue CAGR over the next five years, which – given its considerable operating leverage – would drive its earnings per share growth at a substantially higher growth rate.

LULU has good reason for its optimism, as it just achieved a record for revenue in 2021 of $6.25 billion, of which a stunning $2.1 billion came from the fourth quarter. On top of that, the company has become a free cash flow machine. LULU generated nearly $1 billion of free cash flow on a TTM basis.

Analysts also forecast a 4.8% free cash flow CAGR over the next three years, which is quite impressive coming off of this base, especially when you consider that the company continues to invest aggressively in growth.

Unimpressive Valuation

Meanwhile, LULU stock’s valuation looks discounted relative to its historic levels, following a sharp pullback in the share price in recent months. Its forward enterprise-value-to-EBITDA ratio is 22.9x compared to its five-year average of 25.4x, and its forward price-to-earnings ratio is 37.9x compared to its five-year average of 42.3x.

While those numbers look a bit high, given that LULU is expected to generate a mid-teen earnings per share CAGR over the next half-decade and is highly likely to generate an even higher CAGR if it can achieve its ambitious growth goals over that span, the valuation does not look that far-fetched. Still, with LULU’s best growth days likely behind it, it does not appear to offer a wide margin of safety.

Wall Street’s Take

Wall Street analysts are bullish on the stock, giving it a Strong Buy consensus rating based on nine Buys, three Holds, and zero Sell ratings assigned in the past three months. Additionally, the average LULU price target of $437.75 puts the upside potential at 21.2%.

Summary and Conclusion

LULU stock has an impressive history of generating outsized growth fueled by its compelling brands, product design, and effective marketing. Today, it has generated sufficient scale to become a cash-flow-generating machine, and management is aggressively pushing for further growth in markets where it has yet to make significant headway.

While the stock price has pulled back substantially in recent months – leaving it at a discount to historical valuation multiples as well as analysts’ consensus price target – the company’s best growth days are also likely behind it. Furthermore, with inflationary and supply chain pressures slamming into apparel stocks, LULU may have trouble growing earnings per share at a rate that investors have become accustomed to with this stock.

Suppose inflationary pressures dissipate within a year or two. In that case, the economy can avoid a recession, and LULU can effectively execute its growth strategy. It could deliver outsized returns to shareholders. However, a lot has to go right, and there are too many unknowns to be overwhelmingly bullish on this stock.

As a result, investors might want to wait for a larger discount in the stock to open up before initiating a position.

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