Lululemon Athletica's (LULU -0.03%) stock tumbled 13% on Dec. 9 after the yoga and athletic apparel maker posted its latest earnings report.
For the third quarter, which ended on Oct. 30, its revenue rose 28% year over year to $1.86 billion, beating analysts' estimates by $50 million. Comparable store sales rose 22% (25% in constant currency terms). And net income increased 36% to $255 million, or $2 per share, which also cleared the consensus forecast by $0.02.
Lululemon expects its revenue to rise 24%-26% year over year in the fourth quarter, and to increase 26%-27% for the full year. It expects its EPS to increase 25%-28% year over year in the fourth quarter, and for adjusted full-year EPS (which excludes the gain from a real estate sale) to climb 27%-28%.
Image source: Getty Images.
Those growth rates look rock solid, but the midpoint of its fourth-quarter EPS guidance slightly missed Wall Street's forecast for 28% growth. Lululemon had already been trading at a premium to many other apparel retailers, so it likely needed to hit a grand slam during the quarter instead of a triple to impress the bulls again.
But could this pullback represent a good buying opportunity for investors who plan to hold Lululemon's stock for the next five years?
Reviewing Lululemon's core strengths
Lululemon's annual revenue rose from $2.3 billion in fiscal 2016 to $6.3 billion in 2021 (which ended in January 2022), representing a five-year compound annual growth rate (CAGR) of 22%. It grew faster than many other apparel retailers during that period for three simple reasons.
First, Lululemon established an early-mover advantage in the niche market for high-end yoga and athleisure apparel. It also locked in those shoppers with free yoga classes and other community events. Focusing on that niche market made its brand synonymous with high-end yoga apparel and enabled it to avoid the more saturated sectors of the apparel market.
That's why Lululemon's gross margin rose from 51.2% in 2016 to 57.7% in 2021, even as newer competitors like Gap's Athleta expanded into the yoga apparel market. The company expects its gross margin to dip about 100-140 basis points this year, but that pressure mainly came from currency, supply chain, and inflationary headwinds instead of a loss of its pricing power. For reference, Gap posted a gross margin of 37.4% in its latest quarter.
Second, it expanded its direct-to-consumer (DTC) channel by opening new brick-and-mortar stores and selling more products online. It ended the third quarter with 623 stores, compared to 552 stores a year ago. Digital sales accounted for 41% of its third-quarter revenue, compared to 40% a year earlier, and have grown 46% on a three-year CAGR basis.
The expansion of its DTC channel boosts the visibility of the brand, reduces its dependence on third-party resellers (and the possibility of the brand being diluted through discounts), and enables it to keep pace with other large online retailers. This also widens its moat against other high-profile athletic brands like Nike and Adidas.
Lastly, Lululemon set solid goals and achieved them. Back in April 2019, it introduced its "Power of Three" plan to double its digital revenue, double its men's revenue, and quadruple its international revenue from fiscal 2018 within the following five years. It cleared its digital and men's targets ahead of schedule in fiscal 2021, even as it temporarily closed stores during the pandemic, and it's on track to quadruple its international revenue by the end of fiscal 2022.
But what about the next five years?
Back in April, Lululemon introduced its new "Power of Three x2" plan with the same goals as before. Once again, it aims to double its digital and men's revenues, as well as quadruple its international revenue, from fiscal 2021 within the next five years. The retailer believes that hitting those targets will boost its annual revenue to $12.5 billion by fiscal 2026, which implies its top line will expand at a healthy CAGR of 15% from fiscal 2021.
During the third-quarter conference call, CEO Calvin McDonald said Lululemon saw a "strong start to our Power of Three x2 growth strategy" and that he remained "confident" in both its "near- and long-term plans." McDonald also said he remained "comfortable" with the inflationary pressures, and while other retailers were "now heavily discounting," Lululemon was able to "continue to sell our product at regular price."
So for now, there's no reason to doubt Lululemon's ability to achieve its Power of Three x2 goals. Assuming it generates $12.5 billion in revenue in fiscal 2026 and its stock still trades at about 7 times sales by the end of that year, it could be worth nearly $90 billion by calendar year 2017. That would be more than double its current market capitalization of just over $40 billion.
Lululemon's stock probably won't replicate its gain of about 340% from the past five years by 2027. However, I expect this resilient apparel stock to at least double by then if it fulfills its long-term promises.
