EUR 850.00 For Business Accounts Only

Morningstar | Lululemon Posts Double-Digit Comps and Strong Margin Improvement in 2Q; Shares Expensive

Lululemon outpaced our expectations in the second quarter, as a 10% increase in comparable store sales (versus our 7% estimate) and 48% increase in direct to consumer net revenue (versus our 30% estimate) fueled 25% revenue growth. We continue to see opportunities for top-line growth as the firm expands outside of its core North American womenswear market into new geographies and product categories. Combined comps in Asia were up 50%, with China e-commerce comps up more than 200%. In fiscal 2017, only 9% of sales were generated outside of North America; we expect international stores to account for roughly one third of geographic mix (based on store count) by the end of fiscal 2022, versus around 19% at the end of fiscal 2017. Management also claimed that the men's business reached a penetration of 22% during the quarter, suggesting that momentum within this segment remains healthy. In our opinion, these strong metrics evidence the strong customer relationships and insights into consumer trends that underpin our view of Lululemon's narrow moat.

In response to higher-than-expected comps and strengthened profitability, management substantially raised its outlook for the year, with diluted earnings per share now expected to fall in the range of $3.45 to $3.53 (versus $3.10 to $3.18 prior, and our $3.21 estimate). While we expect to raise our $73 fair value estimate by a mid-single-digit percentage to incorporate a stronger near-term sales outlook, as well as the time value of money, we still view shares as substantially overvalued.

Longer term, we expect direct to consumer sales will continue to outpace comparable store sales, averaging low-double-digit growth and contributing slightly above one third of sales toward the end of our 10-year forecast. Moreover, a shift to the higher margin e-commerce channel (now 23% of sales, versus below 20% in the prior year) should also bolster profitability. In this context, adjusted gross margin expanded 320 basis points to 54.8%, primarily driven by a 260-basis-point improvement in product margin (lower product costs, stronger mix, and lower markdowns) as well as occupancy and depreciation costs that leveraged 70 basis points.