Lululemon Athletica Inc (NASDAQ: LULU)
Growing up in Vancouver, I had the pleasure of witnessing the rise of the Lululemon empire first hand. Back in the mid- 2000s,Lululemon apparel really started hitting its stride: fashion conscious young women began noticeably, and in large numbers, sporting the iconic black yoga pants with the white omega symbol all across Vancouver. As the yoga pants gave way to criticisms, complaints, and memes in the wider public, more and more Lululemon apparel started appearing on the streets. Popularity surged and a little known company from Vancouver, Canada that was once known merely for its black yoga pants is now a $8.5 billion market cap, publicly traded company.
It’s not hard to see that the brand is immensely popular. It dug out a niche in the “athleisure” apparel through fashionable yoga inspired clothing and was a first mover, allowing it to quickly grow market share and command premium margins on its products. It has expanded its product line to include more than just yoga pants: Lululemon sells athletic-leisure shirts, jackets, coats, sports bras, underwear, and other athletic apparel.
Over the past ten years, has grown revenue from $84 million to $1.8 billion. Net income has grown from $1 million to $239 million. Net margin has increased from 1.7% to 13.3%. Free cash flow has grown from essentially zero to $195 million. Operating cash flow has consistently eclipsed net income over the past ten years, which hints at a strong ability to generate cash from the business.
On top of this growth, Lululemon carries very little debt. Current assets, of which 70% is made up of cash and short term investments, outstrip current liabilities by almost 6 times. There is absolutely no long term debt on the balance sheet. It carries a current ratio – total assets divided by total liabilities – 6.3. The balance sheet is very pristine and a thing of beauty to look at.
Based on profitability ratios, Lululemon is generating Return on Assets of around 20%, Return on Invested Capital of around 20%, and Return on Equity of around 22%, all while employing very little financial leverage, as the note on the balance sheet in the previous paragraph indicated.
Looking through these numbers, and first hand experience with the product, it is not hard to see that this is a strong brand with quality cash generating capabilities. Yet, although the enterprise is most definitely attractive, we must analyze if ownership in the enterprise at current prices is attractive. A single stock of Lululemon is currently trading at around $60 per share. With 2015 earnings per share at $1.83, you have to pay 33 times current earnings to buy into the enterprise.
Analysts project growth for Lululemon to be around 15% over the next 5 years. Doing a quick, back-of-the-envelope calculation based on current prices and projected growth of 15%, we can see project that earnings per share could be at $3.68 per share by 2021. Now, if the market is willing to pay the same 33 P/E multiple in 2021, buying at current prices would compound at 15% over the next five years. If the stock experiences some mild P/E contraction and the market is only willing to pay 30 times earnings, you get to compound at 13%. And if the market is only willing to pay a 25 times multiple, you will have compounded at 9%.
Lululemon operates in a fiercely competitive market. The athletic and athletic-leisure apparel sector is strife with competition, with big players like Nike (NYSE: NKE), Under Armour (NYSE: UA), and The Gap (NYSE: GPS). The competition is fuelled by the attractive margins and growing popularity in the “athleisure” style. I think it would be too optimistic to imagine that Lululemon will continue to enjoy a 30+ earnings multiple as competition intensifies for consumer dollars in the sector.
In order to build in a margin of safety, I believe it would be wise to assume a P/E compression into the mid-to-high twenties out in 2021. This would mean that at current stock prices, you could expect the stock to compound at an annual average rate of around 9% to 10%. While these are potentially solid figures and nothing to sneeze at, one could expect similar results with much less risk with a holding in Colgate-Palmolive – all things equal, Colgate is the more logical choice in this scenario as it provides a better risk-adjusted return.
Therefore, while Lululemon is an attractive enterprise, with a pristine balance sheet and a sound economic engine that pumps out torrents of cash for its owners, I wouldn’t initiate a position now, but would rather wait for a more attractive entry point when a dip in the stock price occurs. I don’t believe the current asking price for an ownership stake will provide a superior return to other, better risk-adjusted options.
Disclosure: This author has no positions in any stocks mentioned and does not plan to open any positions in any stocks mentioned for at least 72 hours after publication of this article.