Lululemon Athletica Inc. (LULU, Financial) trades at approximately 33 times consensus 2024 earnings per share. Comparably, the S&P 500 trades at approximately 22 times consensus earnings.
The retail business is extremely competitive and thus, some investors may question whether this premium valuation is deserved.
Legendary investing guru Warren Buffett (Trades, Portfolio) is generally skeptical of retail businesses. In his 1995 annual letter, he said:
"Retailing is a tough business. During my investment career, I have watched a large number of retailers enjoy terrific growth and superb returns on equity for a period, and then suddenly nosedive, often all the way into bankruptcy. This shooting-star phenomenon is far more common in retailing than it is in manufacturing or service businesses. In part, this is because a retailer must stay smart, day after day. Your competitor is always copying and then topping whatever you do. Shoppers are meanwhile beckoned in every conceivable way to try a stream of new merchants. In retailing, to coast is to fail."
However, Lululemon has defied the odds and proved to be an excellent long-term investment for shareholders. Since becoming a public company in 2007, its shares have delivered a return of more than 3,000%. Comparably, the S&P 500 has returned roughly 373%.
The rally has been driven by impressive financial performance. Over the past 10 years, the company has grown both annual revenue and earnings per share at a roughly 20% rate. I believe this strong financial performance can continue and that Lululemon's premium valuation is well deserved.
Growth Opportunity
One of Lululemons' biggest growth opportunities is additional stores. As of the third quarter of 2023, it had a total of 686 company-operated stores globally, roughly half of which are in the U.S. The company's second-largest market is China, where it operates 133 stores. Over the past year, Lululemon has opened 63 net new company-operated stores, including 32 in Asia Pacific, 28 in North America and three in Europe. Comparably, Lululemon's closest peer, Nike (NKE, Financial), operates over 1,000 stores worldwide.
I believe international store expansion represents a massive growth opportunity for the company. While retailing internationally is complex, Lululemon has already proved that is it is capable of succeeding and that its brand has appeal outside of North America.
Another potential growth driver for the company is new product launches. Lululemon recently announced the launch of its men's footwear product line. Men's footwear represents a massive growth opportunity for the company as the market is very big. The men's sneaker market alone is estimated to be worth roughly $32 billion each year. Even modest success in this market has the potential to drive significant revenue growth for the retailer.
Lululemon's men's business more broadly also represents a key potential growth driver. Currently, the company's men's brand awareness in the U.S. is just 13% and is single digits in most other countries. For 2022, men's product sales accounted for just 24% of total revenue.
For fiscal 2023, the company is expected to post total revenue of $9.60 billion. Comparably, industry leader Nike posted total revenue of $51 billion. Thus, I believe Lululemon has significant growth potential before reaching saturation.
Current consensus estimates call for the company to post earnings per share growth of 14.80% for 2024, 14.60% for 2025 and 12.40% for 2026. Given the potential growth drivers referenced above, I believe Lululemon will have no problem meeting or exceeding these estimates.
Reasonable valuation versus peers and historical norms
Lululemon trades at roughly 33 times 2024 earnings. Comparably, Nike trades a roughly 29 times 2024 earnings and 25 times 2025 earnings. Nike's fiscal year ends in May and thus, the 2025 multiple is more comparable to Lululemon's 2024 multiple.
Nike has similar near-term growth prospects to Lululemon and is expected to grow earnings per share by a mid-teens percentage annually over the next few years. However, I believe Lululemon has better medium to long-term growth prospects given it currently has much lower market penetration, especially outside of the U.S. Nike generates 57% of its sales outside the U.S., while Lululemon sees approximately 84% of its sales from North America. Historically, the company has tended to trade at a moderate premium valuation relative to Nike and the current premium is toward the low end of the historical difference in valuations.
Lululemon's current valuation is also reasonable in the context of its own historical valuation. Over the past few years, the stock has traded at an average forward price-earnings ratio of roughly 37. Thus, the current forward multiple of 33 times 2024 earnings represents a discount to the company's recent historical valuation norm.
Based on these considerations, I believe Lululemon is reasonably valued given its strong growth potential.
Risks to the bull case
The biggest risk to the bull case is that the brand becomes less attractive to consumers versus competitors. Lululemon competes in a highly competitive marketplace. Key competitors include Nike, Adidas (XTER:ADS, Financial), Under Armour (UA, Financial), Alo Yoga, Athleta and many other companies. Consumer preferences are difficult to predict, but Lululemon's recent momentum suggests it continues to have attractive products relative to peers.
Another risk to the bull case is an economic slowdown. Consumer spending on athletic apparel is highly discretionary in nature and an economic slowdown could result in lower revenue and earnings growth than is currently expected.
Conclusion
Lululemon is an expensive stock, but has strong long-term growth potential and a history of delivering very strong financial performance.
The company has a number of growth drivers, including additional store openings, new product launches and additional market penetration in its men's business.
The stock trades at a modest premium valuation to its closet peer, but has better long-term growth prospects. The stock currently trades at a moderate discount to its own historical average.
For these reasons, I believe Lululemon's premium valuation is well deserved and the stock is not overvalued at current levels.
