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Will This Be a Kink in Lululemon's Growth Strategy?

By Jennifer Saibil - Jun 23, 2021 at 8:15AM

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Growth signs are strong, but for the stock to be a great investment candidate they need to stay strong.

Even in the early innings of a pandemic recovery, many companies are demonstrating a return to high growth. Lululemon Athletica (LULU 0.44%) posted a blowout fiscal first quarter, with an 88% year-over-year sales increase to $1.2 billion.

Lest you think it's just growth compared to pandemic declines, Q1 revenue represents a 57% increase over Q1 2019. Much of that came from store reopenings, and in-store sales grew more than 100% year-over-year, while digital remained strong with a 55% increase.

A woman doing yoga on a yoga mat.

Image source: Getty Images.

Now that it's operating from a point of strength, lululemon is back to its pre-pandemic growth strategy. But there might be one wrinkle in the company's efforts: store count. Let's see why I see that as a potential problem.

Increasing store count, improving profitability

It wasn't only sales that came back big. Operating margin increased almost 11 percentage points to 15.8% year-over-year, and earnings per share rose from $0.74 in Q1 2019 to $1.11 in Q1 2021. 

For the second quarter of 2021, the company expects sales to increase to $1.3 billion or slightly higher, which would reflect a 2-year CAGR (compound annual growth rate) of 21% to 23%. It expects diluted EPS to be between $1.05 and $1.10, up from $0.96 in 2019. But it expects store revenue to stay flat on a two-year CAGR basis, and all of the growth to come from digital.

The company is still planning to expand its physical presence, though. The athleisure company said that it was planning to open between 45 and 55 net new stores in 2021, slightly more than original guidance of 40 to 50. That's after a slower 2020 in which it opened 30 new stores. As of the end of the first quarter, there were 523 total global stores.

Between elevated costs related to shipping and store reopenings and many new store openings, margins will be somewhat pressured in the coming quarters. CFO Meghan Frank said "Our approach continues to be granted in prudently managing our expenses while also continuing to strategically invest in our long-term growth opportunities."

But there's a second reason why store expansion is both a blessing and a curse for this particular brand name.

A man in workout clothes riding a stationary bike.

Image source: Getty Images.

How much physical does it need?

E-commerce remains an important element of lululemon's total business, although it decreased as a part of the total from 54% in Q1 2020 to 44% in Q1 2021. E-commerce sales increased 55% in Q1. Lululemon customers like to shop online. But physical stores play a role as well in the company's focus on community, and it offers classes in some of its locations. This serves the larger purpose of driving loyalty and sales.

Lululemon is expanding its physical footprint at a time when foot traffic may still be constrained. Its stores in general, as boutique-style storefronts, are fairly small in size, and in the near-term, post-COVID-19 time period, the company will be laying out capital expenditures that won't bring in the same kind of return per new store that it may have before the pandemic.

Increased competition

A separate point to consider is how new categories will perform in the face of competition. Lululemon's core products are women's activewear, but it's making strides in men's products, and increasing men's sales is one of its main goals. 

It's other new foray is into footwear, which it plans to launch next year. That will require a considerable investment in both development and product costs, and it's going up against companies like Nike and Adidas (ADDYY -2.21%).   

Where does that leave investors?

Lululemon stock has delivered big for investors, gaining 370% over the past five years. In terms of revenue, it's gaining on industry leader Nike, but it's still small compared to Nike's $37 billion in fiscal 2020 sales.

The stock is slightly down this year despite the stellar first-quarter report, and that might be because of valuation concerns and mixed guidance. The stock is already trading at a high 40 times forward one-year earnings, and EV/EBITDA is 36, which indicates that the apparel stock may be overvalued.

After several years of high growth and a return after the pandemic, the company had to consider the costs, both literally and in terms of branding, of expanding store count. Investors can still expect long-terms gains from lululemon stock, but new investors should weigh the company's growth opportunities against its valuation when considering buying the stock.

Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Lululemon Athletica, Nike, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool has a disclosure policy.

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Stocks Mentioned

Lululemon Athletica Inc. Stock Quote
Lululemon Athletica Inc.
LULU
$317.80 (0.44%) $1.40
Under Armour, Inc. Stock Quote
Under Armour, Inc.
UAA
$9.33 (0.32%) $0.03
Target Corporation Stock Quote
Target Corporation
TGT
$166.13 (-0.26%) $0.43
NIKE, Inc. Stock Quote
NIKE, Inc.
NKE
$113.87 (-0.53%) $0.61
American Eagle Outfitters, Inc. Stock Quote
American Eagle Outfitters, Inc.
AEO
$12.06 (-0.82%) $0.10
adidas AG Stock Quote
adidas AG
ADDYY
$87.94 (-2.21%) $-1.99
Under Armour, Inc. Stock Quote
Under Armour, Inc.
UA
$8.45 (1.20%) $0.10

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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