Lululemon Athletica: Demonstrating Resilience Through Innovation (NASDAQ:LULU) | Seeking Alpha
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Investment Thesis
The last time I wrote about Lululemon Athletica (NASDAQ:LULU), the focus was on the company’s phenomenal expansion in the international markets, especially in China. In this article, I argue why the company’s ability to innovate rapidly without sacrificing margins will allow it to thrive even in this challenging environment.
Lulu’s Second Quarter Highlights
The company shows no signs of slowing down despite a challenging macro environment. Q2 revenues came in at $2.2 billion, up 18% year-over-year. Diluted EPS came in at $2.68 and was also up 18% year-over-year.
The company further raised its FY23 guidance with revenues now expected to come in between $9.51 and $9.57 billion, which would indicate a year-over-year growth of 17 to 18%. Diluted EPS is now expected to come in between $12.02 and $12.17, much higher than the earlier guidance of a range between $11.74 and $11.94.
Lulu’s Ability to Innovate is Astounding
One of the major highlights of the second quarter was when CEO Calvin McDonald came on the earnings call and laid out the company’s product pipeline, which displayed the company’s ability to innovate at a rapid pace. For instance, the company has taken the Scuba fabric and brought it to the men’s category in the form of Steady State, thereby showing its ability to utilize technical fabrics across genders. Furthermore, the company now plans to launch a new performance fabric designed for cold weather runs and also plans to launch the men’s footwear next year.
Product innovation is one of the core elements of the company’s “Power of Three x2” strategy, and it is clear that the company is taking it seriously. And the innovation is not coming at a significant expense. Adjusted operating margins, for instance, in the second quarter came in at 21.7% of net revenues compared to 20.9% during the same period last year.
It is this ability to not only innovate but also innovate rapidly without sacrificing margins that would, in my opinion, allow the company to come out of this challenging macro environment relatively unscathed.
Lulu’s Inventory Management Continues to be Impressive
One of the major highlights of LULU’s Q2 was how the company continues to manage its inventory levels. The quarter saw the growth in the company’s inventory levels moderate, coming in at 14% year-over-year, lower than the company’s own guidance of 20%. Moreover, the company now expects the growth to slow down further in the third quarter, with current projections of high single to low double digits, before finally growing in line with the sales growth.
What is even more fascinating is that the company did not have to resort to any significant markdowns to bring down the inventory levels, which further suggests that the demand for the company’s products continues to remain robust. While the inventory levels are not at optimal levels yet, something that the management acknowledged during the earnings call, the pace of moderation suggests that the company has the ability to normalize the inventory in the not-too-distant future.
No Visible Cracks in Lulu’s China Growth Story
The investment thesis on LULU cannot be complete without mentioning its performance in China. Q2 saw the company register a 61% year-over-year growth in the region, thereby continuing to demonstrate the company’s popularity there.
The company has 107 stores operating in the region today, and with the majority of the new international stores allocated to the region, there is nothing to suggest that the company’s growth story in China is under threat despite the geopolitical tensions that continue to exist.
$12.10
Source: Company’s Q2 Earnings Release, Refinitiv, and Author’s Calculations
The company is currently trading at a forward P/E of 29x, according to Refinitiv. Historically, the company has traded at a forward P/E multiple of 37x, which in my opinion is justified given LULU’s ability to innovate at a rapid pace.
The company expects diluted EPS to come in between $12.02 and $12.17. At the midpoint value, so $12.10, that would represent a nearly 21% YoY growth, which further justifies the 37x forward P/E multiple.
A forward P/E of 37x and FY23 EPS of $12.10 results in a price target of $448, which represents an 18% increase from current levels.
Risk Factors
While there are numerous positive catalysts for LULU, the company is not without risks. The macroeconomic backdrop continues to remain challenging. North America is still the company’s biggest market, and with the Federal Reserve expected to maintain rates at higher levels for a longer period, how the U.S. consumer reacts, once the pandemic savings dwindle to uncomfortable levels, remains to be seen.
Furthermore, while the company’s ability to innovate has been nothing but astounding, it is not a surety that all of the company’s innovation will translate to revenues, especially if the macro conditions worsen. The extent of damage that an unsuccessful innovative product will have on the revenues and the margins cannot be quantified at this stage, which makes it a significant risk factor.
Concluding Thoughts
LULU had yet another impressive quarter, which in my opinion, is slowly becoming the norm. Management also raised the guidance for the year and demonstrated their ability to manage the inventory levels. But it is the rapid pace of innovation without sacrificing margins that really stands out for me in the quarter gone by. From a valuation perspective, the company continues to be attractive.
Overall, despite the challenging macroeconomic backdrop, LULU continues to be resilient and based on the company’s plans for the coming quarter, the growth story of LULU remains intact.