Lululemon Athletica Inc. (LULU.O), upscale maker of yoga clothing, is expected to report a 2.7% growth in Q4 2015 earnings on March 30. In a weak retail environment, this specialty retailer has managed to overcome a massive amount of negative press questioning the quality of its product. Historically, not many luxury names have been able to overcome this type of setback.
Lululemon’s mean earnings estimate is 80 cents per share, up 2.7% from last year’s 78 cents per share result. Revenue is also expected to show a gain of 15.4%, compared to a year ago (Exhibit 1).
Exhibit 1: Lululemon Revenue Growth
Source: Thomson Reuters Eikon
Sun Salutations
This represents quite a turnaround for a retailer that has made yoga fashions suitable for the “sun salutations” pose into “athleisure” wear, suitable inside and outside the gym.
The last few years weren’t good ones for Lululemon. Founder Chip Wilson’s remark that “some women’s bodies just don’t actually work” in his outfits was criticized. The company embarrassingly recalled a line of pants that were too transparent and it wasn’t immune to the West Coast port labor troubles and winter weather issues. Wilson also pursued a very public fight with the board of directors.
When you are a luxury brand charging a $100 for a pair of yoga pants, the perception is that the quality of the pants is high. However, when the quality of the product is called into question, so is the brand’s reputation. Being a luxury brand means selling the illusion of exclusivity and it’s hard to maintain when it’s mutually dependent on a level of quality.
Lululemon has spent 15 years building a yoga empire. Since the recession, it has been outperforming the apparel industry for the most part (Exhibit 2).
Exhibit 2: Lululemon Outperforms Apparel Sector Same Store Sales
Source: Thomson Reuters I/B/E/S
Growing optimism
Analysts have been becoming more optimistic on its growth plans and raising earnings estimates. What’s more, the StarMine Combined Credit Risk (CCR) model score, the most comprehensive StarMine credit model, corresponds to an implied credit ratings of AA+, suggesting it’s financially stable (Exhibit 3).
Exhibit 3: Lululemon StarMine Model Scores
Source: Thomson Reuters Eikon
Richly valued
Lululemon stock looks as expensive as its yoga pants when examining its intrinsic value. In 2007, the stock IPO price was $18. Our StarMine Intrinsic Valuation (IV) model accounts for the systematic biases that our quantitative research team found in sell-side estimates. Thus, the faster the expected growth rate, the more optimism bias. And more-distant estimates are more optimistically biased than nearer ones.
For Lululemon, after adjusting long term growth estimates for optimism bias, the StarMine IV model places fair value at $33.87 per share. In contrast, the market price is considerably higher at $60.52 per share, suggesting a premium of $26.65 a share and leaving it trading at levels that could be considered overvalued, the StarMine model suggests. Plugging in today’s price and solving for growth suggests that investors are optimistic. Lululemon market expectations are high with an implied 5-yr CAGR of 15.4%.
Exhibit 4: Lululemon Intrinsic Valuation Model
Source: Thomson Reuters Eikon
It looks like Lululemon is ready to come off the mat when it reports results for Q4.
