Why Lululemon Athletica (LULU) Bulls Shouldn't Throw in the Towel Just Yet
Over the first six and a half months of this year, Lululemon Athletica (LULU) has lost approximately $20.4 billion in market value, as the company faces a perfect storm: rising competition, inventory challenges, and a core market that appears to be reaching maturity. While these issues demand serious attention and action from management, Lululemon remains a standout in the apparel sector with margins well above average and returns on capital far exceeding its cost of capital.
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For some, buying into a stock that's still sliding feels like 'catching a falling knife,' but to me, the current price—the lowest in a decade—presents an apparent buy-the-dip opportunity, especially considering the company's solid cushion to potentially turn these structural headwinds around. There are plenty of reasons to be bullish on Lululemon at today's prices, despite its recent struggles.
Things are messy for Lululemon stock right now. It has experienced a significant peak-to-trough decline, falling roughly 41% from its January high of $421 to around $247 today.
And it got even worse after a double-digit drop following its latest earnings report on June 5, when the company slightly beat analysts' estimates. Lululemon's comparable sales were up just 1% year-over-year, with Americas comp sales down 2%, only partially offset by international comps up 6%. However, what really fueled the bearish reaction was the company's reduction of its full-year EPS guidance from $14.95–15.15 to $14.58–14.78 per share.
In my view, these more cautious expectations reflect a combination of competitive pressure, potential product missteps, and a natural slowdown in the U.S. market. While Lululemon has historically handled competition well, new entrants in the premium athleisure space—such as Alo Yoga and Vuori—have been proliferating and capturing market share.
There's also the issue of product assortment. Lululemon has struggled to consistently have the right products in stores. The company underwent changes in its design team, which may have contributed to inventory challenges and product shortages in U.S. locations. Most recently, the company reported that inventory increased by 23% in dollar value and 16% in volume, indicating it's carrying a significantly larger amount of product. That could help support future growth, but it could also backfire. If consumer demand doesn't keep up, markdowns may be needed, which would hurt margins.
Above all, I think these issues have compounded to weaken performance in Lululemon's more mature markets. In the U.S. and Canada, where the brand is already well-established, future growth depends on innovation to avoid market saturation. So, when a product misses the mark, inventory builds up, and competition intensifies, the impact on sales is felt immediately.
It's important to acknowledge that Lululemon's recent challenges aren't solely cyclical in nature. In fact, several appear to be structural—such as increasing competition in the premium athleisure space, market saturation in key regions like the U.S. and Canada, and issues related to product execution and inventory management. These are not short-term headwinds that will resolve on their own; they demand deliberate and strategic action from management.
Even so, there are reasons to remain optimistic. Despite these hurdles, Lululemon maintains substantial profitability, with gross margins at 58.3% and operating margins of around 23%—well above those of its industry peers, such as Nike (NKE) and Adidas (ADDYY), which deliver ~10% and 6.5%, respectively. This margin strength provides the company with significant flexibility to navigate its current challenges while positioning for long-term growth.
Even in this more challenging environment, Lululemon's ROIC over the last twelve months stands at ~23%, only slightly below the 25.5% achieved the previous year. And when you consider the company's cost of equity—using a beta of 0.8, a 10-year Treasury yield of ~4.3%, and an equity risk premium of around 4%—the cost of capital is near 7.5%. From that perspective, Lululemon is still generating strong value creation that exceeds its capital cost.
Even with more cautious forecasts for bottom-line growth this year, I would argue that while ROIC may dip, it's too early to talk about structural deterioration in the company's core fundamentals. There's still a solid long-term story here, if execution improves.
The bottom line is that Lululemon's stock is currently trading at 16.7x earnings, its lowest level in the past decade—at least—a significant drop from the 96x earnings multiple it reached back in 2020 and 65x in January last year.
Based on my calculations, I believe Lululemon is undervalued by about 30% at today's price. Using a reverse DCF model and assuming the market consensus for the next five years top-line CAGR at 8%, with EBIT margins stabilizing around 23.3% (even though consensus expects considerable EPS growth over this period), I estimate Lululemon's free cash flow to the firm in year five years will be roughly $2.2 billion, assuming no changes in working capital.
Bringing that back to present value and discounting at around 7.7%—a rate I find reasonable for a profitable, debt-free, and strong-brand business like Lululemon—and using a perpetuity growth rate of 2.5%, this implies an equity value of about $38.9 billion. That's comfortably above the current market cap of ~$30 billion.
Despite some mixed views, the consensus among 29 analysts covering LULU over the past three months leans moderately bullish. Out of those, 15 recommend buying the stock, 12 suggest holding, and only two advise selling. LULU's average stock price target stands at $310.44, implying approximately 30% upside from the current share price over the coming twelve months.
Lululemon must confront and resolve what increasingly appear to be structural headwinds in order to restore investor confidence and support a sustained recovery in its share price. The encouraging news is that, despite recent downward revisions to growth forecasts, the stock appears undervalued at current levels, provided the company can maintain at least modest revenue growth and stabilize its margins. For patient, long-term investors, this creates a compelling opportunity to capitalize on short-term weakness and establish or add to a position in LULU.
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