Few retailers are performing as well as lululemon athletica (LULU 1.93%) these days. As of the halfway point of 2019, the yoga-inspired apparel specialist has blown past management's growth outlook for five consecutive quarters. And profitability is marching higher as more of its sales base shifts online.
Wall Street has celebrated that powerful combination of market share gains and pricing power by sending shares up nearly 150% since mid-2016. That sharp rally suggests there's plenty of good news already reflected in the stock price. Some of the best returns could still be on tap -- for patient investors.
Laying the groundwork
Lululemon's broad-based outperformance suggests its rebound is about far more than just a few trendy product releases. Sales jumped 22%, year over year, at the start of fiscal 2019 to hold roughly steady against the prior year's 24% spike. The growth came despite competition from Nike (NKE -0.61%) and other rivals that are increasingly targeting yoga apparel.
All the key operating and financial metrics are pointing in the right direction, with market share rising and profitability setting multiyear highs. It's notable that Lululemon has seen its gross profit margin improve by over seven percentage points since 2016 to above 55% of sales. That success implies a Nike-like ability to release innovative products that resonate with its core customer.
Lululemon's business is better positioned for multichannel sales, too, with e-commerce having doubled in just the last two years and already accounting for over one-quarter of sales.
All of these wins put the retailer on pace to easily achieve management's goal of $4 billion of annual sales by fiscal 2020. In fact, its latest outlook hike means revenue should reach $3.7 billion this year.
But that sales figure will need to expand significantly for the retailer to earn its high premium, given that shares are valued at over seven times sales, compared with Nike's 3.6. Investors are paying a similar premium when it comes to profits -- the stock is going for almost 50 times the past year's earnings versus 35 times for Nike.
Paying that price today boils down to a bet that Lululemon can expand its presence into complementary product niches and new geographies over the next few years while continuing to boost its profitability toward 60% of sales. That bullish reading isn't much of stretch. The chain has established a footing in outerwear recently, and its online-focused business and growing brand power should help it travel beyond its current focus in Canada and the U.S.
Still, as the company's struggles in the early part of the decade showed, it only takes a few quality-control stumbles to knock an apparel company right off its growth stride. The stakes are rising, too, since the chain will need to avoid these issues even as it extends into new markets and product niches that it has less experience with.
But as long as investors are comfortable with those risks, there's no reason to avoid Lululemon stock simply because of its high price valuation. The retailer has earned that premium by improving its operating trends since 2012 and putting itself in position to greatly expand its sales base over the next few years. Now it's up to the company to deliver on that promise.