As retailer Lululemon (LULU) approaches its Q2 earnings report on August 29th, I maintain a bullish stance on the stock. With expectations currently very low and the valuation looking de-risked, Lululemon is well-positioned to execute its Q2 strategy more effectively than it did in Q1, making the risk-reward profile more favorable.
While a strong earnings report alone might not reverse the bearish momentum in the short term, especially given ongoing macroeconomic pressures on U.S. consumer spending, it’s difficult to argue against LULU as a buy-and-hold investment. The company’s solid fundamentals—it is virtually debt-free, with a highly liquid balance sheet and strong cash flow—combined with its currently distressed valuation, better reflect the company’s business conditions after this year’s significant sell-off.
In this article, I will delve deeper into why the stock is under such pressure and how the upcoming Q2 results could potentially change its trajectory.
Lululemon’s Recent Roller Coaster
Much of my concern about Lululemon’s investment thesis in recent years centered around its valuation, which has now improved significantly as the company has weathered a “perfect storm.” The stock has lost nearly 50% of its value this year alone and has significantly underperformed the S&P 500 (SPY) since March.
To understand Lululemon’s present situation, it’s essential to look back a bit. As shown in the chart above, last year, the company experienced significant price appreciation, with its stock surging nearly 60% to reach all-time highs by the end of 2023.
Throughout 2023, Lululemon consistently delivered earnings and revenue growth, consistently exceeding analysts’ expectations. The main highlight was its ability to maintain high gross margins while achieving sales growth.
However, it’s important to note that these successes occurred under different market conditions than those we see today. Last year, there was a shift back into growth stocks, especially in retail and consumer discretionary sectors, as inflation concerns eased and the economic outlook improved. With its pristine balance sheet and elevated valuation multiples—averaging a 49x P/E ratio over the past five years—Lululemon’s bullish thesis was reinforced during this period of lower risk aversion.
As 2024 began, LULU stock’s momentum shifted. Trading at high-growth stock multiples, Lululemon needed to maintain strong performance to sustain its positive trajectory. However, the stock lost steam in the first quarter, partly due to renewed inflation concerns and pressure on consumer spending, as highlighted by the Q4-2023 earnings report.
The guidance for 2024 fell well below expectations, highlighting the slowdown in consumer spending in the U.S., where 86% of Lululemon’s revenue is generated. Currently, Lululemon plans to open between 35 and 40 new stores this year, compared to 56 last year.
Even higher-income consumers, who form the core of Lululemon’s customer base, have shown signs of being more cautious with their spending. Consequently, the stock plummeted by up to 20% following the release of the Q4-2023 results, suggesting a potential reassessment of its valuation in 2024. The stock also fell sharply due to intensified competition from brands like Vuori and Alo Yoga, which challenge Lululemon on both style and price.
Lululemon’s Q2: A Turning Point Ahead
Given that Lululemon shares are currently beaten down and expectations are extremely low, I see a strong opportunity to adopt a bullish stance on this retailer. The valuation has significantly decreased from its peak late last year, and with the stock now trading at a forward P/E of 19x, Lululemon’s current price presents a compelling risk-reward profile. In my view, this could be a turning point for the stock.
As we look toward Q2, Wall Street expects Lululemon to deliver earnings per share (EPS) of $2.94 and revenues of $2.41 billion, which would still imply annual growth of 10% and 9%, respectively.
These figures are on the pessimistic side, especially considering that in the last three months, 23 out of 26 analysts have revised their EPS estimates for the June quarter downward, while 21 out of 24 have done the same for their revenue expectations. However, investors should also consider Lululemon’s track record of surpassing estimates, which it has done so consistently over the past few years.
Still, even with a strong Q2 performance, the stock’s momentum may be influenced by ongoing macroeconomic factors. It’s essential to closely monitor gross margins (58.3% on a trailing 12-month basis, among the best in the industry), cost management, and inventory levels. This focus is crucial, given that Q1 revealed some execution issues, such as slower growth in the women’s line compared to men’s, despite a 3% increase in North American sales.
Last quarter, management mentioned during the conference call that opportunities to maximize the women’s business in the U.S. were missed due to inventory planning issues. It was indicated that these problems should be resolved in Q2, with additional innovations planned for the women’s line.
While the outlook for the rest of the year largely hinges on the company’s guidance, these key factors could signal the beginning of a turnaround in the stock’s bearish momentum.
Options Traders Expect Volatility
Furthermore, examining the options chain for LULU stock reveals significant anticipation of volatility. The at-the-money straddle suggests that options traders expect a potential price movement of 11.34% in either direction after the Q2 announcement. This estimate is derived from a $270 strike price, with call options priced at $16 and put options at $13.30.
Is LULU a Buy, According to Wall Street Analysts?
While Wall Street’s consensus on LULU stock is a Moderate Buy, analysts are somewhat cautious. Out of 24 analysts covering the stock, nine have a Hold recommendation, and one has a Sell rating, while the remaining analysts are bullish. Despite this cautious stance, the recent pullback in valuation presents significant potential, with the average price target of $340.17 implying upside potential of 33% from the current share price.
Key Takeaways – Bullish for the Long Term
Lululemon stock has faced significant pressure this year, but with expectations low and the valuation more attractive now, I maintain a bullish stance. The company’s strong fundamentals, including a solid balance sheet and strong cash flow, support this view for the long term. While a strong Q2 performance alone may not reverse the stock’s short-term momentum, focusing on gross margins, cost management, and inventory levels will be crucial in assessing the stock’s potential for a rebound.
