Is This Hot Stock a Buy, Sell, or Hold?

So far this year, lululemon athletica (Nasdaq: LULU  ) has absolutely trounced the broader market. With the macro environment as precarious as it now stands, the high-end retail segment deserves its fair share of caution.

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Considering the yoga guru's healthy run over the past year, is it a buy, sell, or hold?

Buy

  • International: lululemon has been putting up major growth, with last quarter's revenue jumping 31% and net profit soaring 50%. Yet the retailer's footprint remains primarily within Canada and the U.S. It has a small presence in Australia with 14 stores, far fewer than the 45 in Canada and the 106 in the U.S.

    Five years ago, when management was less experienced, the company unsuccessfully attempted to expand into Japan through a joint venture. Less than two years after the foray, lululemon pulled the plug on the four stores it had in the region since it was occupying a "disproportionate amount of management time." At the same time, it announced that Christine Day would become CEO in June 2008.

    Day previously spent 20 years at another retail growth company that has since expanded into more than 50 countries, Starbucks, where she led the coffee giant's International Asia Pacific Group. lululemon still has no physical presence in two of the most important international luxury retail geographies: Europe and China. These are areas on which other luxury retailers, like Coach (NYSE: COH  ) and Tiffany (NYSE: TIF  ) , have been focusing.

    lululemon has been growing its e-commerce platform, with direct-to-consumer sales jumping 71%. Day attributed some of this strength to growth in Germany, the U.K., and France in Europe, and Hong Kong and Japan in Asia. Building brand awareness through online sales lays the foundation for a renewed retail push into emerging markets, and Day has what it takes for lululemon to succeed this time around.

  • The Apple of apparel: lululemon shares a lot of traits with Apple (Nasdaq: AAPL  ) . The Mac maker is one of my favorite companies to cover, and I see a lot of similarities. Both companies are vertically integrated, which not only boosts margins but also allows the companies to mold the retail customer experience from the moment one sets foot in the store.

    This lets them have locations staffed with a knowledgeable sales force, as opposed to having goods sold through third-party retailers whose sellers know little about the dozens of brands on hand. This is a distinct advantage over rival wholesale apparel makers like Under Armour (NYSE: UA  ) . Apple and lululemon boast sales per square foot among the highest in retail.

    Both companies are known for trendsetting design and are able to convey the message that you're buying more than a product, you're buying into a lifestyle. That distinction is what has created a cult-like following for lululemon gear, not unlike Apple's. This brand loyalty is the most striking and important likeness, as it also drives the company's premium pricing power and comparable-store sales.

Sell

  • Intellectual property: Unlike Apple, lululemon has no intellectual property rights on its technology. The company's suppliers own or control the rights to the fabrics and processes used to manufacture the goods, which allows competitors to freely imitate its yoga attire. There are fakes and counterfeits out there, which can hurt the brand perception. A couple of years ago, Nordstrom (NYSE: JWN  ) even poached a lululemon product manager to help design a competing yoga lineup, Zella. lululemon has little to no legal recourse if competitors choose to blatantly mimic its wares.

  • Inventory: Some Fools find lululemon's growing inventory position a cause for concern. It's generally a bad sign when inventory growth outpaces revenue growth, and lululemon's inventory soared by 77% while sales growth rose by "only" 31%. Inventory management is more art than science. Having too little, like lululemon did throughout much of the year, can mean missing out on sales and unmet customer demand. On the other hand, having too much may result in write-offs down the road if those $98 Back on Track running tights jog in place at storage warehouses.

Hold

  • Competition: After lululemon showed other apparel makers that yoga-inspired active gear was fit for growth, rivals have been trying to tap into the market. The Gap (NYSE: GPS  ) bought Athleta in 2008 to spearhead its push. Nike and Under Armour have always been geared toward activewear, but are now drawing inspiration from the yoga trend that lululemon has sparked. Market researcher NPD Group even said, "This trend is 100% driven by lululemon." The company has been managing competition well so far, but the rivalry will be more of a marathon than a sprint.

  • Valuation: Trading at 42 times earnings, lululemon sits at a premium valuation compared to peers. Shareholders like me are already expecting healthy growth going forward. Some analysts have argued that shares are priced for perfection. High-multiple stocks are prone to plunging if their future prospects get called into question.

The verdict
lululemon is still a buy. Its future prospects have never looked better. The company has gained unstoppable momentum and its brand recognition continues to gain traction, which will keep growth coming for years. It has the highest margins among peers, and it has nearly limitless international opportunities.

The inventory balance was $129 million as of Oct. 30, just before Black Friday kicked off the holiday shopping season, which is going swimmingly so far. Building up inventory to meet surging demand is the right thing to do.

I'm expecting lululemon to continue besting rivals, even without patents. Long-term Fools looking for a retail play should give lululemon some serious consideration.

International retail growth in emerging markets is a tremendous opportunity if you know where to look, and it's one reason that lululemon looks so promising. We've just released a brand-new special free report directly from the desk of our chief investment officer that details The Motley Fool's top stock for 2012. The company is positioned to cash in on the explosive growth in emerging markets, and its business model resembles two retail titans you probably visit each week. Check it out now -- it's free.

Fool contributor Evan Niu owns shares of lululemon athletica and Apple, but he holds no other position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Under Armour, Gap, lululemon athletica, Coach, Apple, and Starbucks. Motley Fool newsletter services have recommended buying shares of Apple, lululemon athletica, Under Armour, Nike, Starbucks, and Coach. Motley Fool newsletter services have recommended creating a diagonal call position in Nike and creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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