Making The Case For Lululemon's Rich Valuation

By Will Ashworth | November 22, 2010 AAA

Lululemon's (Nasdaq:LULU) incomplete reporting of revenues has been well documented over the years by numerous news organizations. The lifestyle company's stock keeps chugging along, and now that it's crashed through $50, technical analysts see $70 just around the corner. Even value-oriented traders shouldn't be averse to owning a growth stock or two, so here's a case for Lululemon's rich valuation.
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Recent History
The late Christopher Browne had 16 ways of looking at stock prospects. One of them was to find recent examples of companies sold in similar industries and the valuation received in the buyout. Questions such as price-to-earnings and price-to-book were answered before any stock was purchased. Here, we'll do the same by looking at Bain Capital's recent deal acquiring Gymboree (Nasdaq:GYMB) for $1.8 billion, as well as other retail acquisitions in 2010.

The Price Paid
As mentioned previously, Bain paid $1.8 billion for children's clothing retailer Gymboree. That's 17.6-times earnings, 1.8-time's sales and 4.3-times earnings. On November 23, TPG Capital and Leonard Green & Partners agreed to acquire J. Crew (NYSE:JCG) for $3 billion, paying slightly less in terms of earnings and sales (15.1-times and 1.5-times respectively) than the Gymboree deal, but slightly more, 5.2-times, in terms of book value. Take the two figures for each ratio and average together and then multiply the three ratios and you get 128. The number for Lululemon? 4,022. Breaking this down, Lululemon's P/E is 2.8-times those of Gymboree and J Crew, its P/S is 4.1-times greater and its P/B 2.7-times.

Revenue Growth
Lululemon's five-year compound annual growth rate for revenue is 61.9%. J. Crew and Gymboree have almost identical growth rates with Mickey Drexler's outfit holding a slight edge at 11.9%. Now, take J. Crew's P/S of 1.5 and multiply this by a factor of five and Lululemon's revised P/S ratio is 7.5, higher than current levels. Some of you value people will argue that revenue growth is a separate issue. So let's look at this from the revenue-per-share angle. First, we'll assume that Lululemon's five-year compound annual growth rate for the next five years will be 30% per annum, or half that of the past five years. Revenue per share currently is $8; in five years, it would be $29.70. That's a forward P/S of 1.8, identical to Gymboree. Therefore, if you halve Lululemon's current P/S ratio of 6.8 and then multiply that by $29.70, you get $100.98, which would be the value of Lululemon stock in five years without taking into account earnings growth.

Earnings Growth
On the earnings side, if it were able to maintain its current net margin of 12.9% for the next five years, its earnings per share (assuming the status quo with no addition or subtraction of share count) would be $3.82. The current trailing 12-month earnings per share is $1.17, meaning its compound annual growth rate would be 26.7%. Using this as our forward P/E, we get a future stock price of $102, which amounts to a annual return of 13.6%. This easily beats the indexes.

The Bottom Line
While I don't agree with Lululemon's financial reporting methods, and do see better opportunities elsewhere, those who short this stock are playing with fire because, although its U.S. stores are far less productive than the Canadian ones, they still deliver numbers like no other retailer with the exception of Coach (NYSE:COH). I wouldn't bet against them. (To learn more, see Analyzing Retail Stocks.)

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