Facade of Lululemon shop

Robert Way / iStock Editorial via Getty Images

2021 was an incredible year for the retail sector (XRT), with the index rising by more than 40%, easily surpassing the S&P-500 (SPY). However, despite high profit growth, the Lululemon (LULU) sector had less than 2,500 basis points and has started 2022 in negative territory. After a 25% correction, investors may be eager to get into the stock. However, after changing the nature of ~ 39x in earnings calculations in 2022 and the behavior of stocks, I still don’t see it as a low-risk buying option. Therefore, I think it makes sense to be patient before buying a dip.

Lululemon Athletica(Source: Company Presentation)

More than a month ago, I wrote to Lululemon, warning that the stock had a limited safety margin for its Q3 report, $ 440.00 per share or 55 times the FY2021 earnings estimate. The stock managed to surpass its Q3 calculations, but has since fallen sharply, suggesting that the report was priced almost to perfection. Worse, the stock has begun to change its character, breaking a new 6-month low and breaking below its July 2021 high breaking level. Let’s take a closer look at the bottom:

In December, Lululemon released its Q3 results, which generated ~ $ 1.25 trillion in revenue, a 30% year-on-year increase and a 58% year-over-year increase of 58%. This strong growth was supported by strong male and supplement performance, at 29% and 40%, respectively, according to the two-year CAGR. In terms of geographies, North American revenue rose 28% year-on-year, international revenue rose 40%, and China made progress, with a staggering 70% growth rate according to the 2-year CAGR. With strong results, the company increased its guidance on its annual EPS for 2021 from $ 7.43 to ~ $ 7.73, bringing it to a ~ 56% increase compared to previous pandemic levels.

Lululemon revenue(Source: Company Files, Author’s Diagram)

These strong results led to a steady growth in the units, with 37 new net stores and a 27% increase in sales each year, a 32% increase in sales in the same store and a 23% increase in direct sales to consumers. [DTC] sales. Despite the fact that 96% of stores were open in the third quarter, the 23% increase in the DTC saw strong growth last year. DTC sales were up more than 40% at the end of the quarter, down slightly from 42.8% in the 2020 quarter. Notably, although the cost of air freight rose, gross margins rose by 210 basis points compared to the quarter of 2019 to 57.2%. . This helped Lululemon predict $ 1.62 in EPS, up 69% from the previous pandemic, surpassing the high performance of many of its retail members.

Looking at Q4, the company said it had added 7,000 team members before the holiday season, and inventory levels rose 22% year-over-year at the end of the quarter and ahead of schedule. Meanwhile, all of the company’s plants in Vietnam were open from December, and put the company in a position to deliver strong Q4 results. Based on the thank-you results, the day with the highest e-commerce volume ever for the company, it looks like Lululemon is on track for another solid quarter in Q4.

Lululemon Athletica - Mirror(Source: MIRROR, Twitter)

However, there was a big disappointment in the quarter: the Mirror. For those who lost it, the company bought the home fitness company 18 months ago under a $ 500 million deal and drove $ 250 billion to $ 275 million, more than 60 percent of the 2020 $ 170 million FY. Based on these figures, the purchase price seemed solid, as MIRROR was acquired with almost 2 times the forward sale.

“MIRROR had a strong Mother ‘s Day and is on track to deliver $ 250 million and $ 275 million 2021 in revenue. We continue to take advantage of the Lululemon ecosystem, and by mid-this month, MIRROR will be appearing in nearly 90 lululemon locations in the United States. We’re going to 200 stores in time for this year’s holiday season. ”

– Q21 conference call for 2021

However, the company has since reduced its guidelines by $ 125 million to $ 130 million, and has reported a significant decline in its home fitness system over the years. That is, despite the addition of 200 MIRROR stores in Canada and the United States. While this represents a fraction of the company’s total revenue (less than 5%), a significant negative review of the guidelines is not encouraging. Since the end of the quarter, Lululemon has hired Michael Aragon as CEO of MIRROR and Lululemon Digital Fitness, who previously served as head of content for Amazon (AMZN) Twitch. Fortunately, this is the shake-up needed to revive brand growth, as the results so far have been disastrous.

Despite the clear disappointment with MIRROR, Lululemon continues to grow its BSA by 56% year-on-year and has raised its focus. Large margins contributed to the difficult operating environment for retail / garment companies due to strong supply chain winds and the closure of factories in Vietnam. So it’s pretty clear that Lululemon’s main business is throwing in every cylinder with healthy organic growth and international expansion, which demonstrates its impressive performance against its strategic Power of Three plan (male double, digital double, international quad).

Lululemon EPS(Source: YCharts.com, Author’s Chart)

All in all, although there has been no significant growth since 2015, with a compound annual BSA growth rate of 26.7%, we are seeing a slowdown in earnings growth. This is evidenced by FY2022 and FY2023 at $ 9.18 and $ 10.86, respectively. Assuming that Lululemon can only meet FY2023 calculations, the annual EPS growth rate would drop to 24.7%. Of course, this is still an extraordinary figure, but it is no longer accelerating, which has justified the multiple share premiums compared to other retail brands.

It may have been hoped by some investors that MIRROR could add another important growth pillar to access the content with additional subscription revenue. However, this does not seem to be the case based on the latest results. In fact, if MIRROR fails to surpass its 2021 updated estimates and complete a strong holiday season, sales are going in the wrong direction ($ 170 million -> $ 130 million) year on year. Shoes could be an additional growth area, scheduled for launch in the spring of 2022, but that could dilute margins, even if it leads to an increase in revenue. Let’s look at the rating below:

Assessment and Technical Image

If we look at Lululemon’s valuation, we can see that the stock has seen a significant expansion since its return, and the stock has certainly had a good response, rising by more than 800% in less than five years since the last peak. Over the past decade, Lululemon has historically traded at ~ 36x earnings, and the best time to buy shares has been 30x earnings or less, looking at the previous stock price bottom. While there is no doubt that the valuation has improved since the last 25% correction, it is difficult to argue that there is a large margin of safety here at current levels.

This is because the shares are currently selling at ~ 39.2x FY2022 earnings estimates based on current estimates of $ 9.18. Even if we apply the premium to the historical multiple in view of the large margin spread we have seen and use a larger profit multiple of 44, this still puts Lululemon’s conservative fair value at $ 403.90. This represents a 12% increase in fair value over $ 360.00. Therefore, even if LULU manages to exceed its 2022 earnings estimates, it is difficult to argue that it is an attractive entry point for equities from a valuation perspective.

LULU stores(Source: FASTGraphs.com)

Moving on to the technical photo below, we can see that Lululemon broke below its July 2021 level, with a negative development and a clear change in character. This has put a reduction in the stock’s technical picture, putting a new short-term resistance area at $ 387.00. With a strong support level of up to $ 296.00, LULU has $ 64.00 to hold and only $ 27.00 with potential resistance. This indicates a reward / risk ratio of 0.42 to 1.0, which suggests an inappropriate entry point for the shares. Of course, stocks may bounce back after a sharp drop to start the year. However, I wouldn’t be surprised to see stocks at a resistance range of $ 387.00 – $ 400.00 on any bounce.

In general, I prefer at least a 3/1 reward / risk ratio to justify the introduction of new positions, and according to current forecasts, Lululemon does not come close to meeting this criterion. To meet the 3 to 1 ratio and move to a low-risk buying site, the shares would have to fall below $ 318.50, where the share would be $ 22.50 to support the decline and ~ $ 69.00 for resistance. So while Lululemon is a great company, and is on its way to another record year in FY 2022, I think patience is the best course of action in the stock here instead of $ 360.00.

LULU stores(Source: TC2000.com)

Lululemon had a strong Q3 and, based on the recent guidance rise, BPA is on track to increase its annual BPA by more than 55% from pre-pandemic levels, an extraordinary feat. However, the stock has recently begun to change in character, following the July break and a new 6-month low. Such sharp setbacks have historically provided opportunities to buy, but from a valuation standpoint, I still don’t see enough safety margin here, with LULU trading at nearly 40x of its 2022 profit estimates. In short, I think the best course of action is to be patient before you go shopping, as the next low-risk buying area won’t enter until $ 318.50.