Can This High-Flying Retail Stock Score New Highs?

Tuesday, August 6, 2013 - 10:00am

by Poonkulali Thangavel

Can an apparel company that built its success on catering to women participating in a "touchy-feely" activity repeat that success by marketing to men?

Although this Canadian company has marketed its products to men since it was founded in 1998 -- and earns a surprising 12% of its revenue from that segment -- it is looking to attract men in the U.S. and overseas. However, the company had an embarrassing setback earlier this year when it was forced to recall some of its women's yoga pants because a manufacturing flaw had made them too revealing for some activities. The fiasco sent its stock price reeling to $65 in March from a high above $75 last year.

If you haven't guessed, I'm talking about Lululemon Athletica (Nasdaq: LULU).

The company is now looking to replace CEO Christine Day, who has been at the helm for more than five years. Lululemon's best days may still be ahead, considering that more people worldwide are becoming attuned to maintaining a healthy lifestyle. The company is also looking to grow further by appealing to the youth market and developing fabrics that provide benefits such as ultraviolet protection.

Lululemon sells casual wear and fitness apparel such as pants, tops, shorts and jackets. The company has seen its net revenue grow from $353 million in 2009 to $1.3 billion last year, up more than 250%. During this period, its earnings per share (EPS) have also grown, from 29 cents to $1.88, gaining more than 500%.

The company sells its wares through retail partners and nearly 200 of its own stores in Canada, the U.S., Australia and New Zealand. Although Lululemon sees more near-term potential in the U.S., which accounted for 61% of its profit last year, it is planning to expand overseas into other Asian and European markets, and it already has showrooms in Hong Kong and the U.K. Lululemon has also been increasing its online presence, which accounted for 14% of its net revenue last year.

For its first quarter this year, Lululemon's net revenue was up 21%, to $345 million, from the same period last year, but gross profit was up only 9% after the see-through pants fiasco. EPS for the quarter was flat at 32 cents. For its full fiscal 2013, the company anticipates that net revenue will be up more than 20% from fiscal 2012, at about $2 a share.

Lululemon's margins compare favorably with those of its competitors. Its gross margin of 55% leads those of Adidas (OTC: ADDDF) at 48%, Nike (NYSE: NKE) at 44%, and Under Armour (NYSE: UA) -- which, in contrast to Lululemon, is a male-centered brand that's now reaching out to female athletes -- at 48%. Lululemon's operating margin of 27% is also ahead of the competition.

Lululemon is on an impressive growth track, but the company also faces considerable risks. For one, consumer tastes are fickle, and nobody can say how long Lululemon's image will resonate with consumers before brand fatigue sets in. Many other well-known brands compete in this space, and others could enter.

In addition, Lululemon depends on its overseas suppliers for production and does not have any patent protection on its production processes or the materials it uses. Rising labor costs in China, where Lululemon makes more than one-third of its products, could also cut into its earnings. Not only that, but the company's earnings overseas have to be reported in U.S. dollars, and fluctuations in exchange rates for the Canadian dollar and other currencies could affect its earnings.

Risks to Consider: As a growth stock, Lululemon plows its earnings into its expansion efforts instead of paying a dividend. At a price-to-earnings ratio of nearly 40, LULU is pricey -- but long-term investors will be rewarded if the company's plans for growth take off.

Action to Take --> As the economy continues to recover, this stock, with a beta above 1.0, is also likely to outperform the overall market. The average analyst price target is $77, according to Bloomberg.

P.S. -- It's not farfetched to expect awareness of health and fitness issues to continue to rise -- but you may be surprised by our latest report, "The 11 Most Shocking Investment Predictions For 2014." Our previous predictions have given investors 89%... 92%... 293%... and even 310% gains in a year. To hear our latest, click here.

Poonkulali Thangavel does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.