In the midst of a highly competitive market, lululemon athletica (LULU -0.03%) showed no signs of a slowdown in its fiscal second-quarter earnings report. The yoga apparel specialist posted strong numbers, including a 13% increase in net revenue, that keep the company on track to meet its 2020 goal of reaching $4 billion in revenue.
Going by the modest pop in the stock's price since the earnings report on Aug. 31, investors are encouraged. But this is little solace for shareholders who have held the stock for the last several years.
Are things looking up? Let's take a look at the highlights from the recently reported quarter and what investors can expect going forward.
Lululemon's concept store called The Mile End recently opened in Montreal. The store will be "one part retail, one part community." Image source: Lululemon Athletica
Review of the quarter
In the fiscal second quarter, which ended July 30, revenue increased 13% to $581 million, while comparable-store sales grew 7%. For the full year, guidance calls for revenue to grow about 12% over fiscal 2016, to a midpoint estimate of $2.57 billion. Keep in mind that revenue growth this year will be negatively impacted by the closing of ivivva stores, as that business transitions to digital-only. Overall, recent revenue growth is consistent with the trend of the last couple of years, but the real story is what's happening underneath these numbers.
Adjusted gross margin, which excludes costs associated with the closing of ivivva stores, was 51.6% in the second quarter, an increase of 220 basis points over last year's second quarter. Gross margin expansion is a result of recent efforts to improve supply chain efficiency, as well as higher average selling prices driven by new, innovative product offerings, such as the new Enlite sports bra.
Adjusted operating income was flat, mainly from expenses for the new "This is Yoga" ad campaign coupled with investments to enhance the online business, which increased 29% year over year. This marked the fastest rate of growth for the online business in two years. However, about half of the growth was from an online warehouse sale. Excluding that sale, online growth would have been 16%, still a respectable number. The online sales channel is benefiting from the makeover of Lululemon's website, including new photography and video designed to show off the products much better. Further improvements with the checkout experience are planned in time for the holidays.
Finally, the Asia and Europe segments continue to show very strong growth, with 70% and 50% growth year over year, respectively. As of Jan. 29, 2017, Lululemon had 351 stores, including 11 in Asia and 10 in Europe. Management is following the same growth strategy in Europe and Asia that worked well in North America, which is to concentrate store openings in major cities like London, Paris, and Tokyo and rely on the brand awareness that filters onto social media to grow sales through online channels in smaller cities.
So when might the stock get moving?
Lululemon stock is down about 20% over the last five years, which may lead some investors to the conclusion that the yoga apparel specialist is no longer a good investment. But over the past few years, gross margin has expanded, and earnings have started to grow in proportion to revenue. Therefore, in my view, it would be terrible timing to sell the stock just as management is righting the ship and setting the stage for long-term gains. The days of 30% sales growth are very likely gone, but Lululemon doesn't need to grow that much to get the stock climbing again.
| Metric | Fiscal 2017 Guidance | Fiscal 2016 | Fiscal 2015 | Fiscal 2014 | Fiscal 2013 | Fiscal 2012 |
|---|---|---|---|---|---|---|
| Revenue | $2.57 billion* | $2.3 billion | $2.1 billion | $1.8 billion | $1.6 billion | $1.4 billion |
| Comparable-store sales growth | low single digits | 4% | 4% | (1%) | 9% | 16% |
| Gross margin | roughly 52.2% | 51.2% | 48.4% | 50.9% | 52.8% | 55.7% |
| Earnings per share | $2.39* | $2.14 | $1.86 | $1.89 | $1.91 | $1.85 |
*At midpoint of guidance estimate. Data source: Lululemon.
At the beginning of 2014, Lululemon stock traded for about 36 times earnings -- a price-to-earnings ratio justified for a business that can grow 30% or more per year, which was the rate of growth under previous CEO Christine Day, who stepped down in 2013 amid product quality issues. In the years following Day's departure, Lululemon's revenue growth decelerated to the mid-teens, and earnings stopped growing -- a perfect recipe for a flat-lining stock price.
Today, the forward P/E ratio, based on management's guidance for fiscal 2017 earnings per share is about 22, which better suits a company that is expected to grow at a mid-teens rate going forward. Earnings per share are starting to pick up, but growth in that metric is still lower than revenue growth right now due to the investments management is making to improve supply sourcing, in addition to the extra expense for the new advertising campaign. But these initiatives should continue to strengthen margins and, most importantly, strengthen Lululemon's brand.
