Over the past 12 months, shares of lululemon athletica have risen 90%. The most recent surge came after an upgrade on 2018 holiday season guidance, helping the athletic-wear stock rebound from a slump brought on by a broad stock market sell-off at the end of the year.
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Lululemon has enjoyed several tailwinds. Athleisure (that is, activewear and sports-inspired clothing for all situations) has continued to grow in popularity, and consumers have been generously spending — to the tune of 4.9% more on clothing alone in 2018, according to the U.S. Census Bureau. After a blockbuster run, though, Lululemon may have a difficult time repeating that same success in the new year.
It is easy to see why shares of the clothing company have come roaring back. During the all-important holiday shopping season, management updated revenue guidance to between $1.14 billion and $1.15 billion, up from previous guidance of $1.12 billion. Earnings per share also got an upgrade to a range of $1.72 to $1.74, up from a range of $1.64 to $1.67.
The results are impressive, but Lululemon has been measured by how it approaches expansion. Through the third quarter of 2018, there were 426 physical stores, up a net 22 from the start of the year. Instead of growing primarily by new openings, the company has instead benefited from a surge in same-store sales at existing stores — which increased 6% during the third quarter — as well as directing traffic to the online store. Direct-to-consumer sales were 25.3% of revenue in the third quarter, compared with 21.2% in the same period in 2017.
Lululemon is not alone in the athleisure-wear category, though. Gap and its Old Navy and Athleta brands continue to grow their presence in sportswear, and the largest sports-only chain, Dick’s Sporting Goods, has also launched its own branded lines of clothing. Yet in spite of the competition, Lululemon has continued to resonate with new and existing buyers, both here in the states and abroad.
The maker of stretchy pants and other sports-inspired clothing could nevertheless continue to run higher. After all, Lululemon has momentum on its side, both on the top and bottom lines. Even should sales growth take a breather, management has said it thinks gross profit margin on product sold could continue to expand, especially as a result of the emphasis on direct selling online and new higher-margin products such as coats and sweaters.
On the other hand, there is reason for investors to give pause before jumping on the bandwagon. Even after earnings nearly doubled in 2018, the stock still trades at a premium, largely because share performance matched that of earnings. The trailing-12-month price-to-earnings (P/E) ratio currently sits at 52.5, a metric that only slightly improves to 43.2 when using free cash flow — a better measure of profitability, as it factors only for basic operating expenses and capital expenditures and excludes items such as depreciation and amortization.
On a one-year forward basis, the P/E is currently at 40. Paying for decades’ worth of profits that haven’t yet been realized only makes sense if the bottom line continues to expand at breakneck speeds, and that’s what is implied in the rich valuation. Thus, there’s little room for error, and if there’s any slowdown at Lululemon, the stock could suffer losses at current levels.
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Of course, for those looking to the long term, Lululemon looks like a solid bet on the apparel industry of the future. Nevertheless, after renewed investor optimism over new fourth-quarter guidance, the stock is too rich for my taste.