Is Lululemon Worth the High Price?

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Recently, the stock market hasn't been friendly to athletic-gear retailer lululemon athletica (Nasdaq: LULU  ) . While the stock is up 24% since the beginning of the year, it's down 27% from its high point in May. Does that mean it's cheap enough to be a buy? Not so fast. The company has a lot of interesting things in the wings, but it still might not be enough to make the price right.

The fall
Lululemon's fall from grace was due to its last quarterly earnings report. In it, the company forecasted less growth than investors were hoping for, leading to a 12% drop in the stock price over the following week. Lululemon cited lower margin expectations and an increase in markdowns as the main obstacles to stronger growth. Many investors interested in short-term gains took this as a sign to get out of Lululemon, assuming things were going to get worse.

But the announcements that spurred the price drop were great for long-term investors. They indicated an outlook that stretches beyond any fiscal quarter, and that recognizes the growth limitations that Lululemon is under if it focuses only on yoga. Increases in research and product development should help the company develop a broader customer base. Let's look at what's on the horizon for Lululemon.

It's raining men
Remember when Nike (NYSE: NKE  ) just made shoes? There's a reason it abandoned that idea: Once you get to the top of the market, there's not a lot of room left for growth. Lululemon is now in a similar place, having sold $286 million worth of mainly yoga gear to mainly women last quarter. Since the company operates only 112 stores, there's still room for geographical growth, but it will need to expand its offerings if it wants to continue strong same-store sales growth.

That's where men enter the scene. Lululemon has started selling more men's clothing in its stores, with 12% of first-quarter sales coming from the company's menswear line. This gives the women who shop at the stores more reason to go in, and it should increase the number of men purchasing for themselves as well. It's not a new concept, and Coach (NYSE: COH  ) has recently made a similar move by offering an extended line of men's apparel and bags. The handbag maker saw men's sales double last year to $400 million and is going to expand the range into a third its American of stores by the end of this year.

Dressing the next Anna Pavlova
Lululemon has a theme for its next steps -- things that upper-middle-class women might be interested in. First we looked at men's clothes, and the next in the progression is children's clothing. Since kids aren't historically huge yoga practitioners, Lululemon is instead focusing on ballet, gymnastics, and ice skating with its ivviva line. So far, the brand is open only in Canada, but there are plans for showrooms in the U.S. by the end of the year.

This is another page torn directly from the standard apparel playbook. Gap (NYSE: GPS  ) , for example, launched the GapKids, GapBaby, and GapMaternity lines. Almost every major clothing retailer now has a cleverly named kids' line, and Lululemon is happy to join the party.

The dangers of expansion
The unspoken problem with expanding like Nike and Gap is that now Lululemon is going to be competing with Nike and Gap. Gap has already thrown its hat into the ring with its Athleta brand, which competes directly with Lululemon's yoga lines. A recent report highlighted that of Athleta's 22 locations, 13 are within a mile of a Lululemon. I'm sure that's just a coincidence.

Nike also has a small offering that competes directly with Lululemon, but more importantly it controls the segment Lululemon is trying to break into -- men's athletic gear. In its last quarter, Nike earned 46% more through apparel sales alone than Lululemon earned in total last year. That's a big hurdle to clear.

The bottom line
Lululemon is making all the right moves, as far as I can see. The expansion of the brand into new segments is going to be the best way to create long-term value for shareholders, and the focus on men and children is a natural fit. But Lululemon's forward P/E is still huge, compared with its competitors. Both Gap and Nike are "cheaper" right now, and both are doing interesting things. I like Lululemon, and I like what it's doing, but it’s a little too rich for my taste right now.

Most of the time, being stingy with your investment capital pays off. The cost of overpaying is the cost of investing failure. Luckily, individual investors are often in a better position than their Wall Street counterparts to invest in cheaper companies. The Fool has just released a new report on 3 Stocks Wall Street's Too Rich to Notice. These are "buy what you know" stocks that we think are getting ready to run. Get your free report today.

Fool contributor Andrew Marder owns none of the stocks mentioned in this article. The Motley Fool owns shares of Coach and lululemon athletica. Motley Fool newsletter services have recommended buying shares of lululemon athletica, Coach, and Nike and creating a diagonal call position in Nike. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

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Andrew Marder

Andrew Marder worked in retail for years, holding jobs ranging from bookseller to bank strategy analyst. He has worked for the Motley Fool since 2012, and loves coffee.

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