Lululemon stock: failed breakout after third quarter earnings (NASDAQ: LULU)


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Robert Way / iStock Editorial via Getty Images

2021 has been an incredible year for the retail sector (XRT), with the index rising over 40%, easily outperforming the S & P-500 (SPY). However, despite strong earnings growth, Lululemon (LULU) underperformed the sector by more than 2,500 basis points and started 2022 in negative territory. After a 25% correction, investors might be eager to rush the stock. Yet at around 39x the earnings estimates for FY2022 and after a character shift in the behavior of the stock, I still don’t see this as a low risk buying opportunity. Therefore, I think it makes sense to be patient before purchasing the dip.

Lululemon Athletica(Source: Company presentation)

Over a month ago, I wrote on Lululemon, warning that the stock appeared to have a limited margin of safety ahead of its third quarter report, trading at $ 440.00 per share, over 55x the earnings estimates for fiscal 2021. The stock managed to beat its third-quarter estimates, but has fallen sharply since then, suggesting it was valued near perfect before the report. Worse yet, the stock has started to change character, hitting a new 6-month low and dropping below its major breakout level of July 2021. Let’s take a closer look below:

In December, Lululemon released its third quarter results, reporting revenue of around $ 1.45 billion, a 30% year-over-year increase and a 58% increase over two years. This robust growth was aided by the strong performance of Men and Accessories, up 29% and 40% respectively on a two-year CAGR basis. In terms of geographic areas, North American sales grew 28% year-on-year, international sales grew 40% and China led the way, benefiting from a rate of Incredible 70% growth on a 2 year CAGR basis. Based on the good results, the company increased its annual EPS forecast for fiscal 2021 from $ 7.43 to ~ $ 7.73, resulting in ~ 56% growth from pre-pandemic levels. .

Lululemon turnover(Source: Company deposits, author’s table)

These strong results were driven by steady unit growth, with 37 new stores net year-over-year and revenue growth of 27%, driven by 32% same-store sales growth and 23% growth in direct sales to consumers. [DTC] Sales. This despite only 96% of stores opened in the third quarter and DTC’s 23% growth exceeded robust growth last year. DTC sales represented just over 40% of total revenue at the end of the quarter, down slightly from 42.8% in the third quarter of 2020. Notably, despite headwinds associated with increased sales air freight costs, gross margins increased 210 basis points from third quarter 2019 levels to 57.2%. . This helped Lululemon achieve EPS of $ 1.62, up 69% from pre-pandemic levels, massively outperforming many of its retail peers.

Looking ahead to the fourth quarter, the company noted that it had added 7,000 members to its team ahead of the holiday season and that inventory levels were up 22% year-over-year by the end of the year. of the quarter and ahead of expectations. Meanwhile, all of the company’s Vietnam factories were open in December, placing the company in a position to deliver strong fourth quarter results. Based on the results of Thanksgiving, which was the highest volume e-commerce day on record for the company, Lululemon appears to be on track for another solid quarter in the fourth quarter.

Lululemon Athletica - Mirror(Source: MIRROR, Twitter)

However, there was one major disappointment during the quarter: MIRROR. For those who missed it, the company acquired the home fitness company 18 months ago in a $ 500 million deal and had revenue of $ 250 million to $ 275 million. , up over 60% from around $ 170 million in FY2020. Based on those numbers, it looked like a solid purchase price, with MIRROR acquired for just twice the sales at term.

“MIRROR had a great Mother’s Day and stays on track to deliver $ 250 million to $ 275 million in 2021 revenue. We continue to leverage the lululemon ecosystem, and by mid-month, MIRROR will be featured in nearly 90 lululemon locations across the United States. We’re on our way to 200 shop-in-shops in time for the holidays later this year. ”

– Teleconference Q1 2021

However, the company has since revised its forecast to $ 125 million to $ 130 million, indicating a significant year-over-year decline for the home fitness system. This despite the addition of 200 MIRROR stores in Canada and the United States combined. While this is only a fraction of the company’s total revenue (less than 5%), the large negative forecast revision is not encouraging. As of the end of the quarter, Lululemon has hired Michael Aragon as CEO of MIRROR and Lululemon Digital Fitness, who was previously Director of Twitch Content at Amazon (AMZN). Hopefully this is the reshuffle needed to restore growth to the brand as the results so far have been dismal.

The silver lining is that despite the obvious disappointment with MIRROR, Lululemon is still on track to increase annual EPS by 56% year over year and has raised its forecast. This was helped by strong margins despite the difficult operating environment for retail / clothing businesses due to supply chain headwinds and factory closures in Vietnam. Thus, it is quite clear that Lululemon’s core business is running at full speed with healthy organic growth and international expansion, as evidenced by its impressive performance against its Power of Three strategic plan (double men, double digital, quadruple international).

Lululemon EPS(Source: YCharts.com, author’s chart)

That said, while growth has been nothing short of exceptional since fiscal 2015 with a compound annual EPS growth rate of around 26.7%, we see some deceleration on the earnings growth horizon. This is evidenced by the estimates for fiscal 2022 and fiscal 2023 of $ 9.18 and $ 10.86, respectively. Assuming Lululemon could only meet the FY2023 estimates, the compound annual growth rate of EPS would drop to around 24.7%. This is obviously a still exceptional figure, but which is no longer accelerating, which justifies the premium multiple of the title compared to other brands.

The hope of some investors might have been that MIRROR could add another important growth pillar with additional recurring revenue from subscription to access content. However, this does not appear to be the case based on recent results. In fact, if MIRROR can’t beat its updated estimates for FY2021 and have a strong holiday season, sales are heading in the wrong direction ($ 170 million -> $ 130 million) by a year over year. The shoe could be an area for further growth, with a launch slated for spring 2022, but it could dilute margins, even as it gradually increases revenue. Let’s take a look at the rating below:

Assessment and technical image

Looking at Lululemon’s valuation below, we can see that the stock has experienced significant multiple expansion since its reversal, and the stock has certainly reacted favorably, up over 800% in less than five years before its recent peak. . Over the past decade, Lululemon has historically traded at around 36 times earnings, and the best time to buy the stock has been 30 times earnings or less, given previous lows in the share price. . While there is no doubt that the valuation has improved following the recent 25% correction, it is difficult to say that there is a large margin of safety at current levels.

Indeed, the stock is currently trading at around 39.2 times the earnings estimate for fiscal 2022 based on the current estimate of $ 9.18. Even if we apply a premium to the historical multiple given the strong margin expansion we’ve seen and use a higher earnings multiple of 44, that still places Lululemon’s conservative fair value at $ 403.90. This translates into an increase of only 12% from a conservative fair value of $ 360.00. Therefore, even if LULU manages to beat profit estimates for FY2022, it is difficult to argue that this is an attractive entry point into the stock from a valuation perspective. .

LULU stock(Source: FASTGraphs.com)

Moving on to the tech image below, we can see that Lululemon has fallen below its July 2021 breakout level, a negative development and a clear character change. This put a dent in the technical picture for the stock, with a new area of ​​short-term resistance now in place at $ 387.00. With no solid support level in place up to $ 296.00, LULU has $ 64.00 of downside potential to support and only $ 27.00 of upside to potential resistance. This indicates a reward / risk ratio of 0.42 to 1.0, suggesting an unfavorable entry point into the stock. Obviously, the title could rebound after a sharp drop at the start of the year. However, I wouldn’t be surprised to see the stock meet resistance between $ 387.00 and $ 400.00 on any bounce.

As a general rule, I prefer at least a 3: 1 risk / reward ratio to justify taking new positions, and based on the current outlook, Lululemon is nowhere near meeting this benchmark. For the stock to hit the 3-to-1 ratio and move into a low-risk buy zone, the stock would have to drop below $ 318.50, where the stock would have $ 22.50 lower to support. and ~ $ 69.00 up to resistance. So while Lululemon is a great company and on track for another banner year in fiscal 2022, I think patience is the best course of action rather than rushing into action here at $ 360.00.

LULU stock(Source: TC2000.com)

Lululemon had a strong third quarter and, based on the recent increase in forecast, is on track to increase its annual EPS by more than 55% from pre-pandemic levels, an exceptional achievement. However, the stock has recently started to change character, slumping from its July breakout and hitting a new 6-month low. Sharp pullbacks like this have historically provided buying opportunities, but from a valuation perspective I still don’t see enough headroom here, with LULU trading near 40x earnings estimates for FY2022. To sum up, I think the best thing you can do is be patient before rushing to buy the downside, the next low risk buy zone not arriving before $ 318.50.

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