This year has been a tough one for investors as the S&P 500 is down 20% so far in 2022. Even high-quality businesses that continue to post solid financial results have been getting crushed. The Federal Reserve's intention to hike interest rates in order to curb inflation is sparking fears of a recession, and this is hurting investor portfolios.
One business that is still thriving, Lululemon (LULU -0.39%), is down 29% this year. Any negative price movement like this can cause shareholders to reassess the investment thesis and possibly come to a new conclusion.
With that said, let's dissect the bull and bear cases for this top apparel stock.
What the bulls say
There are a lot of factors for the bulls to be excited about. For starters, Lululemon continues to benefit from strong momentum even as other businesses experience sharp slowdowns in the face of a weakening economy. Besides one quarter, the business still increased sales in every period in the face of temporary store closures during the depths of the pandemic. And in the most recent quarter (ended May 1), Lululemon posted year-over-year revenue and profit growth of 31.6% and 31.1%, respectively.
Key to Lululemon's ongoing success is the strength of its brand. While Nike (NKE 0.57%) reigns supreme in this space, Lululemon is making great strides at becoming more relevant. According to Piper Sandler's spring 2022 Taking Stock With Teens survey, Lululemon ranked third in the clothing category among the Gen-Z demographic. For a company that doesn't specifically target this younger age group, this is quite impressive.
Lululemon's financials are superb, considering that it has significantly increased its net income over the past decade. Credit goes to generating a gross margin of 53.9% in the most recent quarter, which is higher than bigger rival Nike. What's more, even with continued supply chain challenges, Lululemon's operating margin in fiscal 2022 is expected to be in line with that of fiscal 2021, at 22%.
Looking ahead, Lululemon's management team is incredibly optimistic about the company's growth prospects. Between fiscal 2021 and 2026, it expects the business to double annual revenue to $12.5 billion. Doubling men's and direct-to-consumer digital sales, as well as quadrupling international revenue, are key drivers that should help Lululemon reach this goal.
It's strikingly obvious that Lululemon's business is firing on all cylinders today.
What the bears say
With all of the points I just made, it can be hard to find any faults with Lululemon right now. But there are some important bear arguments that investors should know.
While Lululemon has proven its ability to succeed thus far, the fashion and retail industry is extremely competitive. Consumers have an unlimited number of options in front of them from which to choose. And thanks to the internet, newer upstart brands are popping up that are leaning on social media channels to drive awareness and sales. This means that it won't be easy for Lululemon to remain relevant and on top of consumers' minds well into the future.
Besides boosting the men's and international businesses over the next five years, Lululemon has also stepped into the footwear category with the recent launch of the Blissfeel women's running shoe. While management is so far impressed with the initial demand from consumers, it will probably take some time for shoe sales to move the needle for the company. Furthermore, these three areas -- men's, international, and footwear -- will directly place Lululemon head-to-head against Nike, which has long excelled in these segments.
Lastly, naysayers can point to Lululemon's valuation as a reason not to buy the stock today. As of this writing, the shares trade at a price-to-earnings ratio of 35. This is lower than the historical five-year average of 54, but it is still a premium compared to Nike and Under Armour. However, thanks to Lululemon's impressive growth profile and solid financials, the argument can be made that the stock deserves to sell at a higher valuation multiple than its rivals.
Before buying any stock, it's best for investors to understand both the bull and bear cases prior to making a portfolio decision. For Lululemon, I think the positives far outweigh the negatives, and that is why I remain a confident shareholder.
