"Pay for performance" has long been a mantra on Wall Street, and it's a little harder to condemn athletic apparel maker lululemon athletica (Nasdaq:LULU) for its valuation when it continues to perform as well as it does. Not only does the company continue to move truly impressive quantities of premium-priced merchandise, but the company's cautious inventory and expansion philosophies mitigate some of the normal retailing risks. All of that said, investors aren't getting any bargains in these shares.

Guide To Oil And Gas Plays: We've got your comprehensive guide to oil and gas shales in North America.

Another Good Quarter in the Hopper
Not surprisingly, lululemon once again set a bar for performance that virtually no other retailer is going to meet or beat. Moreover, with the Christmas selling season and international expansion both looking solid, there's no reason to think that growth is about to stop.

Revenue rose 37% this quarter, as lululemon saw an 89% jump in direct sales on top of an 18% comp growth. With most analyst expectations clustering in the low-to-mid teens, it was another solid performance for this leading aspirational brand.

Margin performance was not quite as impressive, and some investors may be disappointed in the magnitude of outperformance. Gross margin eased off about 40 basis points (BPS) from last year, but did improve 30 BPS sequentially despite a more concerted effort to keep in-stock levels higher. Operating income rose 35% as the company lost the same 40 BPS in operating margin as gross margin from last year, but saw 70 BPS of sequential improvement.

Competition Trying to Catch up While Lululemon Looks to Lengthen Its Stride
Lululemon has been quite deliberate about its expansion plans - frustratingly so for many investors who would favor a more aggressive approach. Nevertheless, it seems like management is motivated by a very clear focus on preserving the value of the brand and the customer experience (or said differently, "let's not screw up the great thing we have.").

That said, the company is moving on. New product assortments in areas like dance, biking and hiking seem to be getting a good reception, as are extensions into men's and youth categories. Lululemon is also starting to look abroad as a future growth-driver; a good move if the performance of companies like PVH (NYSE:PVH), Oxford Industries (NYSE:OXM) and Nike (NYSE:NKE) are relevant.

While lululemon is thinking about what it wants to be, its rivals are still trying to catch up to what it is. Neither Nike nor Under Armour (NYSE:UA) seem to really be focused on lululemon, while VFC Corp (NYSE:VFC) (lucy brand), Gap (NYSE:GPS) (Athleta) and Limited (NYSE:LTD) (La Senza) are all making investments into stores and promotions to tap into that appealing $100+ yoga pants market.

The Bottom Line
The challenge for lululemon, as has been the case for a while, is managing expectations and dealing with a shareholder base that has been willing to pay very large premiums for the company's future growth. Controlled rollouts of new products reduce brand and inventory risk (lululemon seldom has to worry about sharply marking down undesirable merchandise), but most investors in lululemon don't own it because they're looking for a lower-risk opportunity; they want the growth.

Along similar lines, the Street didn't seem thrilled with management's guidance. Management's target for high single-digit comps seems conservative, particularly as initial signs from the Christmas shopping season have been pretty positive. Moreover, the company seems to be in no rush to push the accelerator on its expansion plans.

Right now, lululemon can be a great company so long as management sticks to its plan (and doesn't make an ill-advised move like an acquisition just for the sake of more growth). Unfortunately, I'm still not of the opinion that it's a great stock. Even if lululemon can more than quintuple revenue from 2011 to 2022 and post an unprecedented free cash flow margin for a retailer/apparel company, the stock is still well ahead of fair value. Considering the valuation and the tenor of today's shareholder base (at least the more vocal parts), I'd continue to admire Lululemon from afar.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  2. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  3. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  4. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  5. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  6. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  7. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  8. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  9. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  10. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center