Wall Street analysts are quite fond of Lululemon Athletica (LULU -0.60%) lately. Wells Fargo and Jefferies both upgraded the company on Jan. 4. Wells Fargo rates Lululemon as "outperform" with an estimated value in the range of $64-$66, and Jefferies is even more optimistic, with a "buy" recommendation and a price target of $70, which implies a big upside potential of roughly 30% for Lululemon from Friday's close.
Investors should always do their own homework as opposed to blindly following Wall Street recommendations. However, there are strong reasons to believe Lululemon could deliver attractive returns in the coming years.
Moving in the right direction
Lululemon has faced a series of difficulties over the past few years. The see-through-pants scandal in 2013 was a major blow for the brand, and management made things even worse by providing an inadequate response at the time. Even after implementing major changes in the management team and the merchandising strategy, inventory and product quality problems remained an issue for Lululemon in 2015.
However, things seem to be be clearly improving. Lululemon reported a big 14% revenue increase during the quarter ended on Nov. 1, with comparable-store sales jumping 9% year over year. The direct-to-consumer sector was remarkably strong during the quarter, growing by 21% on a constant-currency basis and accounting for 18% of Lululemon's total revenue during the period.
Importantly, management specifically said in the earnings conference call that Lululemon's investments in supply chain are already delivering results, so the company expects improving profit margins in the coming quarters. This would be a big victory for Lululemon, as it would prove to investors that the company is finally leaving its problems behind.
Lululemon is finding promising growth venues in different categories and business segments, and this bodes well in terms of financial performance going forward. Comparable sales in women's pants and bras grew 27% and 18%, respectively, last quarter. The men's business is still in the first stages, and Lululemon reported a big 24% increase in comparable sales in this segment. Similarly, its Iviva brand targeted toward younger customers enjoyed a big 23% increase in comparable sales during the quarter.
It looks like 2015 was an important year for Lululemon. The company is finally moving beyond its merchandising problems, so it's now setting the stage for growth in the coming years. Lululemon is barely taking its first steps in international markets, and management believes this could be a huge opportunity over years to come.
Abundant room for growth
Sports apparel is a particularly strong niche in the apparel business, especially when it comes to high-quality players benefiting from powerful brands and trendy designs. Many consumers are using these products for both sports activities and in their everyday lives, a trend that industry analysts refer to as athleisure. Competitors such as Nike (NKE 0.63%) and Under Armour (UAA -3.68%) are obtaining huge rewards from this trend, and Lululemon offers a lot of potential if it can continue down the same road as Nike and Under Armour over the coming years.
Nike is the undisputed heavyweight champion in the industry. The company has a market capitalization value above $100 billion, and it makes almost $33 billion in annual sales. Nike reported a healthy 12% revenue increase during the quarter ended in November, while global future orders jumped 15%. Considering the size of the business, Nike is delivering an impressive financial performance.
Under Armour is truly firing on all cylinders. The company has increased sales at over 20% year over year for 22 consecutive quarters, including a big 28% sales increase during the third quarter of 2015. Under Armour is expecting $3.9 billion in sales for the full year, so Under Armour is still much smaller than Nike in terms of revenue.
Lululemon has a market capitalization value of about $7.6 billion, so the company is less than half the size of Under Armour and only 7% the size of Nike in terms of market value. Measured by revenue, Lululemon is approximately 27% the size of Under Armour and 6% the size on Nike.
If management keeps leading Lululemon in the right direction, then the company has enormous room for expansion, and investors in the company should be attractively rewarded with growing revenues and a rising market value for Lululemon stock in the years ahead.