Lululemon Athletica: China Growth Story A Testament To LULU's Success

Robert Way

Last time I analysed Lululemon Athletica (NASDAQ:LULU), I talked about how the company has been managing its inventory levels with minimal impact to its profit margins.

The company had yet another beat-and raise quarter, thanks to the remarkable performance seen in its international markets in general, and China in particular. In this article, I highlight how the company's international growth and the launch of Lululemon Studio are more than likely to offset any adverse impact from a potential slowdown in the U.S.

LULU had yet another strong quarter, kickstarting the new financial year on a solid footing. Revenues came in at $2 billion, up 24% year-over-year, comfortably beating analyst estimates by nearly $76.5 million. Diluted EPS came in at $2.28, beating estimates by $0.27.

The company also raised its guidance for FY23, with revenues now expected to come in between $9.44 and $9.51 billion, well above the consensus estimate of $9.36 billion. Diluted EPS is now expected to be in the range between $11.74 and $11.94, once again beating the consensus estimate of $11.60.

The growth in revenue of its accessories division, up 67% year-over-year, was particularly noteworthy.

In the fourth quarter of FY22, LULU had posted a 30% year-over-year growth in China despite the Covid protocols in place. In the latest quarter, with the Covid restrictions finally lifted, the company had a blowout performance in China as revenues jumped 79% year-over-year.

The amount of brand awareness, which the company has generated in the region, by leveraging its community-based model is clearly paying off. The growth in China was the major factor behind the company's 60% year-over-year sales growth in its international markets.

With the company expected to open 30 to 35 stores in the international markets in 2023, the majority of which are earmarked for China, LULU's growth story outside North America appears to be far from over.

A major takeaway from LULU's first quarter was the launch of the company's digital app, Lululemon Studio. The platform offers U.S. consumers access to the company's digital content without having to purchase the company's hardware. The membership plan, which costs $12.99 per month, is an additional offering and is separate from the company's free-to-join Essentials membership program.

Lululemon Studio should offer the company with an additional source of revenue and is likely to attract a whole new category of consumers. The company has already had success with Essentials, which saw its membership count reach 8 million within six months of its launch.

According to Vantage Market Research, the fitness app market is forecast to grow, at a CAGR of 17.30%, to $21 billion by 2030. While the Studio may not be the leading player in this category, it is still expected to be a powerful growth driver for LULU, in my opinion, given this category's Total Addressable Market (TAM). Moreover, LULU is more likely to leverage the data generated from Studio to drive innovation in its hardware division.

The company's digital sales in the first quarter accounted for 42% of the total revenue and the digital segment saw traffic jump approximately 30% year-over-year. With Lululemon studio, the company has the ability to drive the growth of its digital division even more.

Forward P/E Approach

Price Target

$438.00

Projected Forward P/E Multiple

37x

Projected FY23 EPS

$11.84

Source: Company's Q1 Earnings Release, Refinitiv, and Author's Calculations

The company is currently trading at a forward P/E of 28x, according to Refinitiv, which in my opinion, is not expensive given the fact that historically the company has traded at 37x. With LULU expected to see its diluted EPS grow nearly 77% in FY23, I have assumed a forward P/E of 37x since, in my opinion, the earnings growth justifies the premium multiple.

A forward P/E of 37x and an FY23 EPS of $11.84, which is the midpoint of the company's updated guidance, results in a price target of $438, which represents a 23% increase from current levels.

The biggest risk factor continues to be the macroeconomic uncertainties, which continue to plague the retail sector.

Furthermore, one of the major catalysts in my thesis is the future performance of Lululemon Studio. There is the risk that the digital app fails to take off. Recall that the company has, in the past, tried to launch a Peloton-like offering, through its acquisition of Mirror. The acquisition today is almost worthless, so LULU does have a poor history with digital offerings. As such, the future performance of Lululemon Studio needs to be monitored closely.

I continue to like LULU. The China growth story is playing out remarkably, especially now that Covid restrictions are removed and thanks to the company's community-based model. The launch of Lululemon Studio offers an opportunity to attract new customers and provides the company with another revenue channel. From a valuation perspective, LULU continues to remain attractively priced despite the jump seen post the earnings release.

Overall, it has been a strong start to the year for LULU and based on the takeaways from the company's Q1 performance, the growth still has legs to run.

This article was written by

Analyst's Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in LULU over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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