The reaction to the fiscal 2024 first-quarter report Lululemon (LULU 1.80%) released on June 5 was positive -- traders sent the stock up to an intraday high of $337.76 on June 6. Since then, though, the share price has been crushed -- falling to a four-year low below $250 on July 25. The stock is now down by just over 50% year to date, making it the second-worst performing component of the S&P 500, behind only Walgreens Boots Alliance.
Here's what's pushing this growth stock down, and why the sell-off could be a buying opportunity for patient investors.
Image source: Getty Images.
Lululemon's red-hot run is over
Lululemon hit an all-time high in December 2023, and it's easy to see why.
Revenue has nearly doubled in three years and operating margins climbed above 20% -- signaling strong demand and pricing power. And Lululemon's results haven't been bad so far this year either. But the price of the stock is now going in the opposite direction of sales and margins.
The main issue is that sales growth is slowing. In the most recently reported quarter, revenue increased by 10% year over year, but comparable sales increased by just 7% on a constant-currency basis. That's a noticeable dip from Q1 2023, when revenue increased 24%, or Q1 2022 when sales were up 32%.
It's normal to expect growth rates to slow on a percentage basis as a business matures. Lululemon is undoubtedly one of the top athleisure brands in the world -- not an up-and-coming company. But it is particularly vulnerable to a slowdown.
Lululemon is built for growth, not a downturn
Instead of relying on wholesale partners like many of its peers, Lululemon gets most of its sales through company-operated stores and its direct-to-consumer channel. A natural comparison would be the contrast between Tesla and the auto industry's established players. Tesla doesn't sell its vehicles through networks of independent dealers -- it sells them directly to consumers through its stores and online, and supports the operation with its own service centers and charging network.
That sort of business model gives Lululemon more control over its operations. However, it also adds to its fixed costs and makes the business bulkier, which could amplify the negative financial impacts in the event of a sizable decline in demand.
The company's sales, general, and administrative (SG&A) expenses are significant. For every dollar in sales generated during the last 12 months, Lululemon spent $0.35 on SG&A expenses compared to $0.42 on the dollar for cost of goods sold.
LULU SG&A Expense (TTM) data by YCharts.
Marketing is an important component of brand development. However, excessive SG&A spending can inflate a company's cost structure and make it overly reliant on sales growth to offset those high costs.
New kids on the block
In addition to macroeconomic challenges, Lululemon is facing tough competition -- particularly from Alo Yoga -- which is directly going after Lululemon's market share. Lululemon helped pioneer athleisure, especially in popularizing yoga pants as an everyday apparel option. But seven to 10 years ago, the brand was lesser known, and the company was much smaller from a sales standpoint. Lululemon is now at a stage where it has a commanding presence in the market, but it doesn't have the entrenched foothold of a more time-tested brand. This leaves it more exposed to changes in consumer preferences and fads.
Nike (NKE 0.66%) has been dealing with the same macroeconomic and consumer-behavior challenges as Lululemon. Nike faces rising competition from On Holding and Hoka (which is owned by Deckers Outdoor). But Nike is the largest and most recognizable apparel brand in the world. It is simply in a different league as Lululemon. And even so, its stock price has collapsed to its lowest level in more than five years -- illustrating just how extreme the challenges the industry faces right now are.
Lululemon trades today at a mere 20.4 price-to-earnings ratio, which is dirt cheap for the stock historically. But that valuation could begin to look quite expensive if sales growth continues to slow. The biggest bear-case risk for Lululemon would be if its earnings actually began to contract due to the combination of its bloated cost profile and changing consumer preferences. The company could also determine it needs to dial back prices to ward off Alo Yoga and other brands. The combination of those concerns and the macroeconomic backdrop explains why the stock has gotten obliterated over the last seven months.
Lululemon is a cautious buy
Lululemon was once a high-flying stock, and it has been moved to the discount rack for mostly good reasons. Now more than ever, it's important not to overlook the challenges the company faces both as a brand and in catering to cost-conscious consumers.
However, it's equally important to recognize how far Lululemon has come. It is achieving strong growth in international sales and men's clothing, suggesting it can diversify its business and become less reliant on selling women's clothing in the North American market. The stock is also inexpensively valued now, even if its sales remain sluggish over the short term.
Lululemon has sold off enough to make it a buy. However, investors should pay close attention to the brand's health and management's approach to SG&A expenses. If Lululemon throws money at marketing campaigns that end up failing and eroding margins, then that may be a signal that the brand's power is weakening and the stock deserves a low earnings multiple.
