The Driving Force for Even Higher Growth at Lululemon Might Not Be What You Think

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Should analysts indefinitely chase up their ratings and targets on companies they follow? It’s rather complicated, but this is a scenario that many investors find themselves contemplating if they have followed Wall Street research through the ups and downs of companies and the stock market.

Thursday’s slate of top analyst upgrades and downgrades included a key analyst upgrade of Lululemon Athletica Inc. (NASDAQ: LULU), and it may be one of those instances in which some investors wonder if the call is just late or whether there is additional insight. That said, the analyst sees high growth in what many outsiders may not have considered to be within Lululemon’s traditional market.

Argus raised its Lululemon rating to Buy from Hold and raised its 2019 and 2020 estimates. The new price target is $150. What might stand out about this upgrade is that this call was long after the Lululemon turnaround. It’s also after the stock has risen close to 60% so far in 2018 alone and after shares have more than doubled from this time a year ago.

Many analyst calls from Wall Street’s sell-side firms get questioned. After all, the analysts covering stocks are ultimately being paid by commissions of some sort. What makes this upgrade different, even if some investors might wonder if it’s too late, is that Argus is truly an independent research firm. Its analysts are not tied to any traditional commission structure that sell-side research firms might currently have or may have had in the past. Argus is not a registered broker-dealer and does not have investment banking operations.

Another issue to consider about the upside here is that the $150 target now matches the street-high analyst target price. Thomson Reuters previously had a consensus target price of about $123.50.

Argus raised its fiscal year 2019 earnings estimate to $3.40 per share from $3.21 per share after the first-quarter earnings came in higher than what the firm expected. The estimate of comparable sales also was raised, and fiscal year 2020 expectations on earnings were raised to $3.80 per share from $3.55. This new $150 price target implies a multiple of 44 times the independent research firm’s fiscal year 2019 earnings estimate.

One driving force for the call is a rapid e-commerce expansion, followed by strong overall growth, expansion in North America and internationally, and high gross margins. Another issue for the focus has been the double-digit growth seen in Lululemon’s apparel for men.

Also worth noting was that Lululemon recently appointed Calvin McDonald as chief executive officer, and he had served as president and CEO of Sephora’s Americas unit. The Argus team thinks McDonald’s background will be beneficial to Lululemon as it seeks to tap into international markets and grow its e-commerce segment. The report further noted:

We recently reduced our five-year compound annual EPS growth rate forecast to 15% from 20% because the business is growing and becoming more mature. We still see significant growth opportunities in the domestic, international and men’s businesses. Sector-wide demand appears strong, but LULU’s leadership position is being challenged by growing competition and the potential for competitors to seek new, lower priced distribution channels as Under Armour did in choosing to sell merchandise through Kohl’s.

In our view, the company has the potential to open additional stores in the U.S. and internationally. The challenge, of course, isn’t to simply open stores. The challenge is to open highly productive stores, and the company has an innovative process that is helping it to achieve sales of over $1,100 per square foot in the first year a store is open, compared with an old target of about $750 per square foot. The more mature Canadian stores, with sales of approximately $2,800 per square foot, are approximately 40% more productive than the U.S. stores. This implies potential for further gains in the U.S. stores as they build a loyal customer base in their trade areas. The average store has sales of about $1,500 per square foot.

The Lululemon stores of yesteryear may also not be what the public thinks of the company ahead. Argus noted that the company is planning to grow sales by providing merchandise for more sports and activities. Running now accounts for about 20% of the business, and the men’s business has significant upside and could ultimately be worth 25% of sales within the next few years alone.

Its ivivva concept is now said to be poised to grow as an online product rather than through square footage. And while yoga-inspired products for women are expected to keep dominating the business, Lulu’s other categories targeted for growth are running, swimsuits and leisure gear, as well as adding a wider range of sizes.

Lululemon shares were trading up 3% at $130.25 midday Thursday. Its 52-week trading range is $56.56 to $131.88, and its market cap is now $17.1 billion.