Narrow-Moat Lululemon Slides Into 2023 With Strong Momentum; Shares Overvalued

Lululemon’s LULU fourth-quarter results for 2022 exceeded its preliminary announcement and our expectations (see our Jan. 9 note). Moreover, the firm offered guidance of 15% sales growth and $11.50-$11.72 in EPS (excluding share repurchases) for 2023, close to our 14% and $11.59 respective estimates but, given its momentum, likely conservative. Thus, we expect to lift our near-term forecast, leading to a mid-single-digit percentage increase in our $233 per share fair value estimate. However, we view Lululemon’s shares, up 13% in postmarket trading, as overvalued, at roughly 30 times forward earnings. We rate the firm as having a narrow moat and view it as a leader in the athleisure space, but believe its valuation does not fully reflect the threat of competition.

Lululemon’s 30% fourth-quarter revenue growth eclipsed our 27% forecast. Its e-commerce channel has remained very strong coming out of the pandemic, accounting for 51.8% of total revenue versus our 49.5% estimate. Although Lululemon opened about 80 stores (net) last year, we anticipate its digital sales, a major part of the Power of Three x2 plan, will remain above its physical sales on a permanent basis.

Lululemon’s adjusted gross margin was 57.4%, 30 basis points above our forecast but down 70 basis points from last year. The company entered the quarter with elevated inventories that necessitated some discounts in a promotional market. While it closed the quarter with inventories up 50%, we do not view this as a concern given its strong full-price sell-through. We think it can hold 58% gross margins in the long term.

Lululemon’s adjusted gross margin outperformance coupled with in-line operating costs resulted in a 28.3% adjusted operating margin, 20 basis points better than our estimate. We model Lululemon’s adjusted operating margins to improve to about 25% by the end of the decade from 22.1% in 2022 as it leverages its costs over a larger revenue base and higher-margin online sales grow.