Sept 14 2020 - Lululemon: Always Overvalued

Lululemon released Q2 earnings, crushing earnings and revenue expectations.

The company is set to grow revenue year over year for FY2020. Considering we are in the middle of a pandemic, this is exceptional for a retail business.

The stock has been hid hard over the last week, falling ~20%. There is potential for further losses, but support is coming in quick.

As the market has taken a bit of a step back here (down 6% over the last five days), stocks are also taking a hit. Lululemon (LULU) has fallen ~20% in those same five days, including a gap down of almost 10% after releasing earnings that killed expectations yet again. The "sell the news" mantra rolls on for now. The company is in a spot where it is set to actually grow revenue year over year for FY2020, which is incredible given the COVID-19 factor. Lululemon is leaning heavily on the e-commerce side of the business to carry the water, and it is doing that and more. I think the company will continue to grow long term, but we may see some further turbulence in the stock price right here.

(Source: Google)

How Were The Earnings?

On Tuesday night, Lululemon released Q2 earnings. Some of the highlights are as follows:

• GAAP EPS of .66, a beat by .11.
• Revenue hit 2.94 million, a beat by .56 million.
• Company-operated stores' net revenue was 7.2 million, a decrease of 51% compared to the second quarter of fiscal 2019.
• Direct-to-consumer net revenue was 4.3 million, an increase of 155% compared to the second quarter of fiscal 2019.
• At the end of the quarter, the company had 3 million in cash and equivalents.

(All data from the earnings report)

What do I take from this? The first thing I notice is that revenue actually increased by 2% year over year. Given that we are in the middle of a global pandemic where many are "supposed" to be struggling financially, this is incredible. What is interesting is the growth in online sales. Direct-to-customer revenue totaled 61.4% of total net revenue for the quarter. To me, this speaks to the brand strength that has been created by the company. Lululemon has said that it is going to accelerate the investments for the e-commerce platform. This is smart given the growing gap between in-store sales and direct-to-customer. These investments include developing site enhancements, building its transactional Omni functionality, and increasing fulfillment capabilities.

As for the balance sheet, it remains in phenomenal shape. Gross margin did fall slightly (2%), but product margin remained the same as last year. The company ended the quarter with .2 billion in total liquidity. This is made up of 3 million in cash and equivalents, and the capacity under its committed revolving credit facilities was 7.7 million. This gives the company a lot of flexibility. It has in debt, which is always a plus.

(Source: TIKR.com)

As for what's coming down the road, the company did not provide much guidance due to COVID-19. But if we have learned anything from Lululemon, it is how quickly the company has been adapting to the scenario. You do not get the above revenue chart looking the way it does without that capability. Lululemon has committed to opening 70 seasonal stores in Q4 to aid the Christmas rush. This is very smart, as I expect social distancing will still be in place for many of its stores and will help relieve some of the pressure for the lines. To think that we are expecting year-over-year growth for the company in 2020 is quite spectacular. Not very many companies can say that, especially in the retail market.

What Challenges Does The Company Face?

The landscape is ever-changing, thanks to COVID-19. As I mentioned earlier, Lululemon has proven its ability to adapt to any environment. In doing so, it went out and spent 0 million to buy Mirror. For those that don't know, Mirror is a startup out of the United States that capitalizes on working out at home. In other words, Lululemon is betting that people will continue to work out at home once the pandemic subsides. This was a bit of a head-scratcher for me. I, for one, cannot wait to get back to the gym. The company is expecting to generate 0 million in revenue in FY2020 from Mirror. While this is a small chunk of the pie, if it can pull it off, there is a nice subscriber fee that would be collected monthly on top of the ,500 price tag for the setup. The company has said it is going to shift its marketing to more at-home workouts, which should play into Mirror quite nicely if it catches fire. CEO Calvin McDonald had this to say:

As trends around the world are shifting to working and sweating from home with an increased focus on health and wellness, we believe 2020 is likely an inflection point for retail and for lululemon... We are cautiously optimistic with regard to the second half of the year as we continue to navigate the uncertain environment.

(Source: The Verge)

What Does The Price Say?

Even though the company has crushed earnings, that does not change its current valuation, which, as you can see below, is absurd right now. This is partially what lead to my short position from basically this point, back on June 15th when I called for a price correction. Well, I got my price correction, it just came too late. I did get stopped out really quickly for a small loss. I currently do not have any positions in Lululemon. What we are seeing now is sort of what I was looking for, but I have a hard time going short, as the stock is already down 20% off the highs. Even Seeking Alpha's Quant rating has the value rated at an F. Although, all other categories score much higher.

(Source: Simplywall.st)

Looking at the charts, it does not look all that pretty right now. Looking below, we can observe an hourly chart. In the past, I have outlined how crucial the 200-hour moving average is. Looking below, we can see that the yellow line has been solid support since the crash in March. Looking a couple of days ago, we can see a lot of turbulence at this level before gapping well below it. This is not positive, as it will likely prove to be resistance going forward. Secondly, we can see that there has been some resistance created at the 7 level. This could prove to be a short-term ceiling for the stock as well.

(Source: TC2000.com)

Moving to a daily view, we can get a better picture of where the stock may look to consolidate or make a turnaround attempt. For me, that is around 3. There is some previous support there from a few months ago, as well as the 200-day moving average. Both of these levels should help cushion the stock if it does continue to slide. It is at this point that I would look to enter for a turnaround.

(Source: TC2000.com)

While this has been the year of V-like recoveries, I have a hard time believing that Lulu will rally in a V shape simply due to the run it has had. There has been some heavy selling volume, and the greater market may determine which way this goes from here. I do think the stock falling back to 3-ish would be a good thing (not only so I can get in), but it will shake out loose hands and likely slowly grind higher from there.

Wrap-Up

Let me be clear. I do not think this stock is headed back to sub-0. I think much like the clothing the company produces, the stock will always be overvalued. Especially if the company continues to crush earnings as it has over the last handful of years. The brand is extremely well-established, but remains overpriced even after the 20% decline. At the very least, some consolidation is needed to allow for the fundamentals to catch up to the price a little bit. I remain bullish Lululemon long term, but I am happy sitting on the sidelines for now. Stay safe out there!