Should Investors Buy Into the Recent Lululemon Athletica (LULU) Hype

The month began with athletic apparel retailer lululemon athletica inc. (LULU) reporting its earnings for the first quarter of the fiscal year 2023. The company surpassed both top-line and bottom-line expectations to take the Street by pleasant surprise. Its revenue jumped 24% year-over-year to $2 billion, while its earnings per share came in at $2.28.

While decades-high inflation and increased borrowing costs instituted to rein it in have been weighing heavily on consumers’ budgets and forcing middle-income consumers to trade down the value chain to budget-friendlier options, high-income segments have been relatively unaffected.

Hence, LULU, which sells high-end yoga pants, shoes, and other athletic wear, said it had seen no changes in its customers’ shopping habits. In fact, despite raising its prices around this time last year, the retailer still found shoppers flocking to its stores and filling up their digital carts. This led to 13% and 16% year-over-year increases in comparable store sales and direct-to-consumer net revenue, respectively.

According to CFO Meghan Frank, LULU has also been helped by lower air freight costs and the reopening of the Chinese economy, as the revenue from the country alone grew by 79% from the previous-year period when about a third of its 71 stores there were closed due to strict restrictions under its “Zero-Covid” policy.

As a result, LULU’s gross margins increased 3.6 percentage points to 57.5% in the quarter, above the 56.7% analysts had been expecting. The company’s stellar performance has encouraged it to expect its second-quarter sales to be in the range of $2.14 billion to $2.17 billion, representing growth of about 15%, and diluted earnings per share to be in the range of $2.47 to $2.52 for the period.

For the full year, LULU has raised its guidance. The company expects its revenue to be in the range of $9.44 billion to $9.51 billion, up from a previous range of $9.31 billion and $9.41 billion. Also, it expects EPS to be $11.74 to $11.94 compared to the earlier estimate of $11.50 to $11.72.
Moreover, it expects to open 50 net new company-operated stores in the fiscal year, with a majority of 30 to 35 planned for international markets expected to open in China.

The bullish outlook was promptly reflected in the price action, with the stock surging by more than 12% in extended trading after the earnings release.

Our Take

Notwithstanding LULU’s bullishness regarding its prospects, retailers across the industry have cited a pullback in discretionary spending and higher-ticket items. In fact, during the earnings call of Nordstrom, Inc. (JWN), its executives noted that although the high-end customer is “pretty resilient,” they’ve also become more cautious.

Secondly, with the $500 million acquisition of Mirror in June 2020, fueled by misplaced expectations that people would continue to exercise at home, even after Covid pandemic restrictions ended and gyms reopened, turning out to be a dud, LULU’s at-home fitness business is in jeopardy.

While the company has approached its competitor, Hydrow as a potential buyer for Mirror, it has since incurred $443 million in impairment charges and has rebranded its at-home fitness business as Lululemon Studio. The segment has also pivoted from being solely hardware-focused to launching a new digital app that gives its members access to its fitness classes without needing to buy its hardware.

Lastly, but perhaps most importantly, as mentioned earlier, sales growth in China over a small base during the previous year-period due to strict public-health restrictions has been responsible for LULU’s recent outperformance. Achieving a similar growth rate this time around will be challenging in an economy whose faltering recovery is evident from the 7.5% year-over-year decline in exports in May.

More ominously, for a company whose primary target segment is the young and upwardly mobile, China is facing a demographic decline. Moreover, high competition and a grueling “996” work culture have been giving rise to countercultural trends such as “tang ping” (lying flat in Chinese) and “bai lan” (let it rot) while driving an ever-increasing switch from a white-collar job to “qing ti li huo” (or light labor in Chinese).

Bottom Line

While the momentum of LULU that is expected to sustain itself in the second quarter could help traders make quick money by the time the company’s next earnings release is due, seldom, if at all, has big money been made by investors buying what is hot on the Street.