lululemon athletica's (LULU 4.43%) stock has surged roughly 650% over the past five years as the high-end yoga and athleisure apparel maker has repeatedly impressed investors with its robust sales growth.
It expanded its brick-and-mortar footprint as other apparel retailers shut down, it maintained its premium brand appeal even as cheaper competitors entered the market, and it locked in customers with free yoga classes and community events.
But after those big gains, investors might be wondering if Lululemon's stock is getting overheated at more than 50 times forward earnings. That valuation might seem high for an apparel retailer, but I believe that premium is justified, for three simple reasons.
1. Consistent sales growth
Lululemon's revenue rose 24% in 2018, and grew another 21% in 2019. Its direct-to-consumer (DTC) sales, which mainly come from its online and brick-and-mortar stores, increased by 45% in 2018 and 35% in 2019. Its DTC sales accounted for 26% of its sales in 2018 and 29% of its sales in 2019.
In the first nine months of 2020, Lululemon's revenue rose 4% year over year to $2.67 billion, even after the pandemic shut down its stores in the first half of the year. Its sales dropped 17% in the first quarter but rose 2% in the second quarter and 22% in the third quarter as its e-commerce sales accelerated and its stores reopened.
On a constant currency basis, Lululemon's DTC revenue rose 70% year over year in the first quarter, 157% in the second quarter, and 93% in the third quarter. That robust growth enabled Lululemon to bounce back much faster than other athletic apparel retailers.
By comparison, Nike's (NKE 3.26%) revenue fell 4% in fiscal 2020 (which ended in May) and dipped 1% in the first quarter of 2021. Adidas' (ADDYY 0.94%) revenue plunged 20% year over year in the first nine months of 2020. Lululemon didn't provide any guidance last quarter, but analysts expect its revenue to rise 8% this year and 25% next year.
2. The "Power of Three"
Last year, Lululemon unveiled its "Power of Three" growth plan, which aimed to generate double-digit annual revenue growth through the end of 2023 by doubling its men's revenue, doubling its digital revenue, and quadrupling its international revenue. Lululemon's management reiterated its commitment to that plan during last quarter's conference call, even as the pandemic temporarily throttled its growth.
Lululemon's sales of men's apparel only generated 21% of its revenue in the first nine months of 2020, but that percentage could rise as it prioritizes new product launches. Its digital sales should also continue rising as more brick-and-mortar shoppers start making purchases online.
Lululemon only generated 15% of its revenue outside of the U.S. and Canada in the first nine months of the year, but its overseas revenue is rising by double-digit percentages. The APAC (Asia-Pacific) region is leading that growth, and its revenue from China more than doubled year over year in the third quarter.
Looking ahead, Lululemon's recent acquisition of Mirror, a remote workout start-up that streams video workouts to a $1,500 wall-mounted machine, could help it challenge Peloton Interactive (PTON 9.89%) in the home workout space and expand its booming e-commerce business. The upcoming launch of its first shoe collection in early 2022 could further strengthen its brand, diversify its portfolio beyond apparel, and widen its moat against Nike, Adidas, and other industry peers.
3. Stable margins and earnings growth
Lululemon's gross and operating margins expanded in both 2018 and 2019. But during the first nine months of 2020, its gross margin dipped 40 basis points year over year to 54.3%, while its operating margin fell 480 basis points to 13.5%.
It attributed those declines to COVID-19 expenses, markdowns, higher fulfillment costs for online orders, and digital marketing expenses for Mirror. But Lululemon still maintained consistently higher margins than Nike and Adidas, which ended their latest quarters with gross margins of 44.8% and 50%, respectively.
Nonetheless, Lululemon's contracting margins still reduced its net income by 25% year over year to $259.1 million during the first nine months of 2020. Analysts expect its earnings to drop 8% for the full year.
But next year, analysts expect its earnings to jump 48% as the pandemic headwinds wane and its revenue growth accelerates again. Investors should always be skeptical of analysts' long-term forecasts, but that growth rate suggests the stock isn't too expensive at 50 times forward earnings.
The key takeaway
Lululemon's resilience throughout the retail apocalypse and the COVID-19 pandemic, which forced many retailers to file for bankruptcy, indicates it's still a "best in breed" player in a crowded sector. As long as it continues to expand its digital and brick-and-mortar presence, stays focused on its "Power of Three" goals, and maintains its brand appeal, its stock should be well worth the risk -- even if it trades at a premium to other apparel retailers.