Lululemon (LULU) has built a strong brand, known for its premium athleisure wear made from superior materials. However, the stock has recently taken a significant hit, with the share price plunging 40% year-to-date. Its key competitor, Nike (NKE), has also underperformed, experiencing a 14% drop year-to-date.
Given that a great brand like Lululemon has seen its stock price hammered, the more important question is whether LULU is a good buy now.
From a price-multiple comparison standpoint against Nike, Lululemon looks like a bargain.
LULU grew its revenue by 19% from a year ago, while NKE only managed to pull in 2% growth. However, they are priced similarly, with their PE ratios in the twenties and FCF yields of over 4%. This suggests that LULU’s growth is underpriced now. Even the PEG ratio indicates this, at 0.3, where a ratio below 1 is considered cheap for its growth.
The foremost reason for LULU’s poor stock performance is that its revenue growth rate has slowed. Although LULU beat growth estimates in 4Q23, it gave an uninspiring guidance of 9-10% revenue growth for 1Q24, and full-year FY24 growth is expected at 10-12%. These figures continue to show LULU’s slowdown in growth, and thus LULU’s value has to be adjusted downwards in tandem with this growth retardation.
Analysts’ ratings vary widely due to uncertainties about whether a young, fast-growing brand like Lululemon can sustain its growth rate. Different assumptions about growth rates have resulted in price targets ranging from as low as $240 to as high as $550. Morningstar’s valuation is $285, and the current price of $303 is closer to the lower end of the range than the upper end. This suggests that the market has priced in most of the pessimism.
But we also need to address the elephant in the room – why is LULU’s growth slowing and is it permanent?
Post-COVID Demand Normalization: LULU was one of the beneficiaries of stay-at-home COVID lockdowns. As workers could exchange office wear for comfortable leggings suitable for home exercises and double up as working attire. As lifestyle begins to normalize post-COVID, so has the demand for athleisure products.
Inflation Impact: Inflation has started to bite, and consumers are pulling back on spending in some areas. This impact is visible in companies like Starbucks and Apple. It is not surprising that LULU has also suffered from lower spending on its premium goods.
Rising Competition: New competitors, such as Alo Yoga, have emerged. Alo Yoga offers similar products but has managed to carve out a following among Gen Z and Alpha consumers. Competition can be a more permanent problem than demand normalization or inflationary pressures. LULU needs to maintain brand awareness and loyalty; otherwise, it may lose its appeal, positioning, and eventually market share. Under Armour is a cautionary tale where it enjoyed a meteoric rise and eventually faltered, failing to compete successfully against Nike.
To add to the problem, Chief Product Officer Sun Choe has resigned, and LULU is not replacing the role but rather restructuring the department. Although we do not know the reason behind this decision or the specific strategy LULU is pursuing, it is perceptively viewed negatively, suggesting that LULU might be facing some internal challenges.
On one hand, LULU is a great brand with superior margins, and now the stock is attractively priced. However, on the other hand, I am uncertain about how permanent the issues affecting its business and growth will be. I don’t have a clear sense of its future, and it falls into Warren Buffett’s definition of the ‘too-hard pile’—investment opportunities that are outside one’s circle of competence or are too complex to analyze with a reasonable degree of certainty. So I’ll pass.
