Many consider Nike the king of sports apparel, but competitor Lululemon Athletica (LULU 1.31%) has been the superior investment since the stock's initial public offering (IPO) in 2007. The company recently reported its fourth-quarter earnings for 2022, and investors rejoiced, sending shares soaring.
Is the stock worth buying after climbing more than 16% in the past month? Fortunately, it seems that the party might not be over yet. Here are four reasons Lululemon could maintain its momentum.
1. Thriving direct-to-consumer sales
Wholesale distribution to third-party retail stores used to be the key for athletic footwear and apparel companies. To get access to consumers, top brands had to fight for shelf space from retailers.
However, Lululemon quickly realized the value of a direct-to-consumer business model. Lululemon owns and operates brick-and-mortar stores, which accounted for $1.1 billion in Q4 sales, up 15% year over year. That segment represents 40% of the company's sales.
Moreover, the internet has empowered brands like Lululemon to go direct to consumers more efficiently. Lululemon's e-commerce sales represented almost 52% of total revenue in the fourth quarter, increasing 37% year over year to $1.4 billion.
Just $225 million, or 8% of revenue, came from Lululemon's other segment, which is wholesale. In other words, over 90% of sales go directly to consumers via company-owned stores or online. Controlling distribution helps the company earn higher profit margins by cutting out the middleman.
2. Taking market share in a competitive space
Lululemon's control of its distribution also helps it control branding. The company has complete control over its marketing and product staging and doesn't deal with competitor products sitting on the shelf next to it.
That can create a superior brand experience, leading to increased market share. Management noted on its earnings call that the company gained 2.3 points of market share in the U.S. during Q4, despite the sports-apparel category's revenue shrinking by 5%. Management noted that it increased its share each quarter in 2022, and Q4 was the best quarter since Lululemon began tracking the metric in 2020.
How should investors perceive this? It could signify that Lululemon is taking market share from weaker competitors. If the category is shrinking (perhaps due to tightened consumer spending), customers may be flocking to premium brands like Lululemon.
3. Profits could keep growing
Lululemon has put together a strong decade of performance, growing sales by an average of nearly 20% annually. The company's accelerated revenue growth in recent years bodes well for its bottom line. Analysts believe the company can grow earnings per share (EPS) by an average of almost 18% annually:
LULU Revenue (Annual YoY Growth) data by YCharts.
Is this realistic? It would seem so, considering Nike is more than six times bigger by annual revenue.
Please don't take this as a prediction that Lululemon will become as large as Nike, but the Swoosh company is still growing sales at a double-digit pace, despite its size. It shows that market size shouldn't limit Lululemon. Instead, it could maintain its growth rate if consumers continue running with its brand.
4. The stock is still reasonably valued
To recap, Lululemon is posting strong top- and bottom-line growth. The brand is succeeding by going direct to consumers and growing its market share. Does this all mean the stock is a buy? It could mean that the business will grow profitably, a key ingredient to what makes a good investment.
However, the price you pay for a stock matters, too. Fortunately, despite the recent share-price jump, Lululemon seems like a reasonable buy today. Consider that Nike, which is growing more slowly, trades at a forward price-to-earnings ratio (P/E) of 38 today. Lululemon is trading at a P/E of almost 32, a 16% discount to its larger competitor.
I don't typically consider many stocks cheap when trading for more than 30 times earnings. Still, if the market's awarding such a high valuation to Nike, Lululemon's valuation seems justified, given its bright prospects.
