Shares of the athleisure pioneer have taken a major hit.
Lululemon Athletica (LULU -0.75%) just reported revenue and earnings for the first quarter of its new fiscal year that beat Wall Street estimates. It’s no wonder shares jumped immediately after the news.
Zooming out tells a different story, however. At Wednesday’s prices, this beaten-down apparel stock was roughly 40% off its all-time highs.
Investors might be looking at Lululemon as a potential portfolio addition. Before you make an investment decision, here are three things you need to know.
Growth potential
Perhaps the main reason why shares of Lululemon are down so much is due to a revenue slowdown. The top line expanded by 10% in the latest quarter (which ended April 28). While that’s respectable in its own right, it’s a far cry from the huge gains that were registered in the last three full fiscal years.
This business is not immune from the macroeconomic environment, which is pressuring consumer discretionary spending. When talking about inflation and higher interest rates, CEO Calvin McDonald said, “It’s weighing on the mind of the consumer, and we also know they will spend, but they’re being selective.”
Investors might do well to focus on the bigger picture. Lululemon still possesses sizable growth potential. In Q1, sales in China soared 45%. This is a big opportunity, as the country has a massive middle class. “Our new store openings of 2024 will include five to 10 stores in the Americas, with the rest in our international markets, primarily in China Mainland,” CFO Meghan Frank said on the Q1 earnings call.
Despite the recent slowdown, the executive team is still optimistic Lululemon can achieve its “Power of Three x2” growth plan, which calls for revenue to reach $12.5 billion by the beginning of 2027, up 30% from the fiscal year that ended this past January. McDonald believes the business can get to a point where 50% of its revenue comes from North America and 50% comes from international markets, a huge change from a split of 73% and 27%, respectively, today.
Premium status
Lululemon has long focused on selling higher-end apparel. This strategy puts it in the premium category in the industry. The company also doesn’t rely much on third-party retailers to sell its products; instead, it uses its own e-commerce channel and physical stores. This helps management maintain tighter control over inventory and merchandising, which can support the brand’s strength.
It’s no wonder that Lululemon is extremely profitable, as it has proven to benefit from pricing power. In the past five years, the business’s gross margin and operating margin have averaged a superb 56.5% and 20.5%, respectively. These figures are much better than Nike‘s averages, demonstrating Lululemon’s ability to turn revenue into earnings.
High profits allow the leadership team to return capital to shareholders in the form of stock buybacks. In the latest full fiscal year, $559 million was used for this purpose.
Compelling valuation
Over the past three years, shares of Lululemon have fallen roughly 9%. That’s a very disappointing run, especially when you consider that during the same stretch, the S&P 500 and Nasdaq Composite have risen 28% and 25%, respectively.
But at this point, the stock trades at what I believe is a very compelling valuation. Investors can scoop up shares at a price-to-earnings ratio of 25. That’s near the stock’s cheapest valuation multiple in the past decade, indicating the market’s pessimism toward the company.
Based on Lululemon’s growth prospects and strong profitability, I believe investors are being presented with a worthwhile buying opportunity today. Of course, with any apparel business, the key risk to always be mindful of is how intensely competitive the industry is. Consumer tastes and fashion trends are constantly in a state of flux, and changes can make any brand irrelevant in no time.
For what it’s worth, Lululemon’s successful track record speaks for itself. So, I think investors should give the company the benefit of the doubt. Over the next five years, the stock has a good shot at outperforming the market.
Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Lululemon Athletica and Nike. The Motley Fool has a disclosure policy.