Traditional value investors probably didn't like Lululemon Athletica (Nasdaq:LULU) before Friday's earnings report, and they are not likely to appreciate it any more afterward. So, for those who think the secret to successful stockpicking is in targeting single-digit EV/EBITDA ratios, sub-1.0 PEG ratios, or similar formulas, Lululemon just is not going to work for them.
For growth investors, though, this is a name that just keeps delivering the goods. There will be a day of reckoning, a day when the growth disappoints and investors suddenly realize that the low-hanging fruit has been plucked, but that day isn't today and it does not look like it's going to be tomorrow either. In the meantime, aggressive investors may continue to benefit from one of the most dynamic stories in retail.
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A Strong Start to the Fiscal Year
Lululemon delivered 35% revenue in the fiscal first quarter, with comp-store sales up 16% in constant dollar terms. Few retailers are approaching this sort of growth these days. That said, it looks like maybe Wall Street has caught up to the name a bit - the company did surpass the average analyst estimate, but not by much and the company definitely did not beat the highest end of the range.
Profitability continues to outpace revenue growth. Gross margin was boosted by 140 basis points from a tax credit, but that still leaves 350 basis points of regular old margin expansion. That's not bad in an environment where retailers left, right and center are worried about production cost inflation. Operating income was likewise strong, as the company reported 59% growth here on the way to an overall earnings beat relative to Street expectations. (For more, see Analyzing Retail Stocks.)
Enjoy the Ride, But Take Note of the Exits
Lululemon is a great growth story today and there are ample opportunities for new store openings and product line expansions. What's more, nothing is quite so irritating as selling a growth stock after a double and then seeing more patient investors enjoy a triple, a quadruple, or so on.
That said, experienced investors have seen this story before. Gap (NYSE:GPS) was once a hot growth stock until it pretty much saturated its market and no longer seemed trendy. Crocs (Nasdaq:CROX) was going to take over the world with its weird foam resin shoes ... until it didn't. Likewise, bebe stores (Nasdaq:BEBE), Chicos (NYSE:CHS), and Under Armour (NYSE:UA) all had their big rises and subsequent falls.
So, it's probably inevitable that Lululemon will stumble at some point and investors will see the stock cut back by at least one-half. The real questions, though, are when that happens and whether the company (and stock) rebound. Lululemon looks far from a point of market saturation, but competition from Nike (NYSE:NKE), Adidas (Nadsaq:ADDYY.PK), Under Armour, and others could begin to bleed away sales well before then.
What should investors do to protect themselves? Keeping a close eye on same-store sales trends and product line expansion is a good starting place; if these metrics weaken, institutional growth investors will flee and the stock will weaken. Investors should also consider a trailing stop loss, which is an order that adjusts as the stock moves up. While selling out on momentary "turbulence" may sound like a curse to a growth investor, suffering a 50% drop is much worse.
The Bottom Line
With many retailers struggling to get customers through the door or opening their wallets once they're inside, Lululemon is truly a beacon in a growth-starved industry. With that growth in place, Lululemon has attracted a shareholder base that just doesn't care about backward-looking metrics. That's fine in a healthy market and/or when company's are in that hyper-growth phase. The problem comes when the market sours on risk or when the company's growth stumbles.
I cannot pretend to know when Lululemon will stumble, so I cannot say growth investors should avoid this name. What I can say is that I've seen this movie before, though, and I know the second act is where the hero finds that the going gets really tough. (For more, see How Far Can Lululemon Stretch?)
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