David Olive: Lululemon seems fit to thrive, even amid the uncertainties of economic reopening

David Olive: Lululemon seems fit to thrive, even amid the uncertainties of economic reopening
Lululemon Athletica Inc., one of Canada’s most valuable companies, is beginning to stand out among its peers in the market for athletic leisure wear, or “athleisure,” that it helped create. And to do so while still profiting from the sector’s strong growth compared with the larger apparel market.

Yet investors have lately soured on the at-home fitness sector, after making pandemic stock winners of Lululemon, Nike Inc., Peloton Interactive Inc. and Nautilus Inc. On average, those stocks have dropped about 25 per cent in share value from their 2020 peaks, including an 18 per cent slide in Lululemon shares.

But this flagship Canadian multinational, a household name in many of the 17 countries on four continents in which it operates, has more growth potential than a currently skeptical market is so far willing to assign it.

Lululemon, based in Vancouver, is more upbeat about its near-term prospects, as you would expect. “We’re in the early innings of our potential,” claims Calvin McDonald.

The Lululemon CEO is forecasting record revenue of about $7.1 billion in the company’s current fiscal year, a 27 per cent jump from the last one. That would make this a banner year for Lululemon, eclipsing its 25 per cent revenue gains in FY 2019.

But a big drop in Lululemon’s same-store sales during the pandemic has put a fright into many stock analysts. Never mind that the firm posted an 11 per cent sales gain last year, as the impact of lockdowns at the firm’s 520 stores was overcome with a surge in online sales by one of the industry’s most loyal customer bases.

Since online sales are more profitable than those of traditional stores, Lululemon was able to improve its gross profit margins last year. The investor caution is not surprising, though. There is no certainty about when depressed pandemic economic conditions will lift. And there’s no telling which changes in consumer preferences during lockdown will continue into the post-pandemic, and which will be abandoned as we get back to normal.

Lululemon investors are especially uncomfortable with uncertainty, given the firm’s pricey stock. The shares currently trade at a lofty price-earnings multiple of 64 times trailing 12-month adjusted earnings per share, even with the recent share-price decline factored in.

The market was expecting higher projected earnings for the current year than the company forecast in late March. That prompted a harsh reaction from Wells Fargo analysts, who wrote in a client note that “Lululemon’s premium valuation makes it tough to swallow numbers moving lower” (than the Street expected).

But amid the current doubters about the stock is a loyal fanbase among analysts, observers who are influenced by the near-ninefold increase in Lululemon’s stock price over the past decade. With total shareholder value of about $52 billion, Lululemon sports a bigger market cap than Magna International Inc., Loblaw Cos. or Suncor Energy Inc.

That mix of Lululemon’s record of rewarding investors and the unpredictable pandemic outcome explains the wide range of analysts’ current future expectations for the stock. Their medium-term target prices have the shares gaining between seven per cent and 44 per cent from their current price of $386.

Finally, the stock-price declines among other vendors of athletic apparel and fitness gear cast doubt on the entire sector’s growth potential. Abrupt price drops have also hit the stocks of pandemic darlings Peloton Interactive Inc. (down about 30 per cent from its 2020 peak), Nautilus Inc. (down 45 per cent) and Nike Inc. (down six per cent).

But a telling distinction between Lululemon and Nike and the sector’s other erstwhile pandemic winners is that Lululemon and Nike were thriving before the pandemic. They lead the sector in expansive product lines, powerful brand names, and robust distribution networks, including their own physical and online stores and third-party vendors.

Lululemon stands to gain if the at-home leisure wear and fitness boom continues, even in diminished form, after the pandemic. And it’s poised to benefit from an upturn in sales of away-from-home gear, resulting from pent-up demand and the full reopening of its bricks-and-mortar retail network.

“Our continued growth,” McDonald asserts, “demonstrates our ability to win before, during and after COVID-19.”

Peloton and Nautilus, whose share prices more than quadrupled last year, sell at-home athletic equipment and fitness systems. That part of the sector was bound to deflate with an anticipated reopening of gyms and fitness centres.

Meanwhile, three years earlier than planned, Lululemon has achieved a goal set in 2019 — to double its online revenues, with a big assist from the pandemic and heavy investment in e-commerce. What’s more, in recent quarters, sales growth in men’s apparel and accessories has come close to matching increases in women’s gear sales, a promising sign that Lululemon can hit its target of doubling sales from its men’s collection by 2023.

International sales (outside Canada and the U.S.) got a boost last year from China, the first G20 country to almost fully reopen its economy. Lululemon expects to open an additional 20 stores in China this year, part of its plan to quadruple international sales in the next two years.
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