The stock chart may not be reflecting it, but Lululemon Athletica (LULU 2.64%) is having an incredible year. Through the first nine months of 2022, revenue for the apparel company is up 29% to $5.34 billion, and net income is up 36% to $735 million. Shares sold off after the last earnings report on weaker-than-expected guidance for the busy holiday shopping season. Lululemon expects Q4 sales to jump "only" another 25% year over year.
With just a couple of weeks left to go, shares have now fallen nearly 17% in 2022. Now could be a great time to add this top athletic wear stock to your portfolio before 2023 begins. Here are three reasons why.
1. International business is booming
Lululemon is still growing at a strong pace on its home turf (uh, or home yoga mat) in North America. But international expansion is especially promising, even in difficult economic times for the global economy.
As a reminder, the company's stated goal was to quadruple overseas sales from 2021 to 2026. In Q3 2022, international sales were up 46% year over year, keeping Lululemon on track to reach that objective. What's especially impressive about this pace of expansion is that it includes a record run-up in the U.S. dollar (which lowers the value of an international sale when the local currency is converted back into dollars), hot inflation that has spending at other athletic wear companies sweating, and economic lockdowns in China.
On this last point, Lululemon could be getting some reprieve. China is reportedly loosening some of its zero-COVID policies, which would bode well for the country's flagging economy -- and for clothing stores. Lululemon said 22 of its stores were closed in China during Q3. Even still, sales increased nearly 70% from last year, driven by both rising in-store and online sales. An end to COVID-19 lockdowns in China could further boost this key growth market.
2. The digital sales segment is top-notch
Lululemon has a global store base of just 623 locations, which it continues to grow at a brisk pace in high-foot-traffic areas. However, the key to Lululemon's success (and to driving eventual foot traffic to new stores) has been its online channels. Lululemon's online and app traffic increased 50% year over year in Q3.
What's impressive about that rate is that while many e-commerce retailers have been slowing down this year as the early effects of the pandemic ease, Lululemon is still going strong. On a three-year compound average growth basis, e-commerce traffic is up 41%. That means Lululemon's Q3 online growth was actually up more than the average over the last few years. Clearly, Lululemon's digital team knows how to connect with and acquire new customers.
To help support this expansion, management has been building out new distribution centers in key geographies. A new one near Vancouver, B.C., Canada just opened last quarter to help cover sales and orders in Western Canada. The aforementioned increase in China revenue is also a testament to the company's work in strengthening its supply chains around the globe to meet the rising demand for its products.
3. Lululemon's profit could be ready to surge
Lululemon has notched a nice increase in net income this year, but there's plenty of room for this figure to run even higher in 2023. That's because some expenses are actually up quite a bit and keeping a cap on this apparel company's margins.
The strong dollar has had an effect on margins overseas, as have ongoing air freight shipping costs (which are finally starting to ease up a bit). Capital expenditures also climbed this year and were $176 million in Q3 alone (a 43% year-over-year increase), earmarked for distribution centers and new store openings. Spending to grow inventory has also been ongoing this year as Lululemon recovered from a sparse assortment of gear in 2021 due to supply chain issues. Inventory on a dollar basis jumped 85% year over year in Q3.
Some of this spending, like capital expenditures and inventory, will ease up heading into the new year. The U.S. dollar's rapid rise should also cool off as the Federal Reserve gradually slows its pace of interest rate hikes in 2023, too. All of this means Lululemon could have operating leverage -- meaning its profit margin could expand. Even now, though, Lululemon has some of the best apparel retail margins around at over 21% in the last one-year stretch. For the sake of comparison, mighty Nike (NKE -0.36%) generated an operating margin of just over 13%.
Based on the last earnings update, shares trade for 36 times trailing 12-month earnings. Management also still had about $812 million remaining on its share repurchase program. More repurchases would also help boost profit on a per-share basis. Given Lululemon's exceptional execution of its growth strategy, the stock looks like a top apparel company buy to me as 2022 draws to a close.
