First, let’s get one thing clear. Few apparel companies have seen as much success over the past several quarters as Lululemon (NASDAQ:LULU). Lululemon stock absolutely has been on fire thanks to huge improvements in comparable sales and profitability.
This success promises to continue for the foreseeable future because the company is still in the early stages of transitioning from niche, U.S.-focused women’s yoga pant retailer, to mainstream, global athletic apparel retailer that appeals to both men and women. As this transition plays out over the next several years, Lululemon stock will head higher.
Having said that, I think Wall Street is getting too optimistic on the name.
A Closer Look at Lululemon
Recently, Wells Fargo upgraded LULU stock to Outperform (from Market Perform) while slapping a $200 price target on the stock. The rationale? Recent sales momentum will persist well into 2019 thanks to improved product, a potential loyalty program, and international expansion.
But, at nearly $160, I’d argue Lululemon stock is already priced for this. The stock is trading at a huge premium to historical standards, the market, peers, its sector, and its long-term earnings growth potential.
Plus, the stock is up more than 150% over the past year, and trading at a 50%-plus premium to its 200-day moving average (that premium is right around 5-year highs).
In other words, Lululemon stock is expensive and has come very far, very fast, all in anticipation of big growth for the next several quarters. Consequently, I don’t think a $200 price target makes sense for this stock. Operational out-performance should keep Lululemon on a winning path, but the days of 100%-plus annualized gains are in the rear-view mirror.
Lululemon Will Continue Heading Higher
Lululemon has been red-hot lately, and the success has everything to do with this company breaking out of its shell.
Traditionally speaking, Lululemon was a niche, U.S.-focused women’s yoga pant retailer that had a devout core demographic, but not much awareness outside of that niche. Men wouldn’t be caught dead wearing the brand. Appeal outside of yoga-wear was limited. International presence was null.
That has all changed dramatically.
Today, Lululemon is turning into a global athletic apparel retailer with wide reach that extends far beyond the women’s yoga market. More men are wearing Lululemon clothes, and appeal outside of yoga-wear is rapidly growing. Consumers increasingly are adopting Lululemon shorts, shirts, sweaters, so on and so forth. And the international business is red-hot, led by aggressive expansion in Asia.
This transition from niche to mass market is still in its infancy. Lululemon is slated to do just over $3 billion in sales this year. Between other mass-market athletic apparel giants like Nike (NYSE:NKE), Adidas (OTCMKTS:ADDYY), Under Armour (NYSE:UAA), and Skechers (NYSE:SKX), sales range from ~$5 billion to nearly $40 billion.
Thus, if Lululemon can continue to grow its brand presence and awareness in markets outside of Yoga, the runway for future growth is quite promising.
Because of this strong narrative supported by a big long-term growth runway, LULU stock should head higher for the foreseeable future regardless of valuation friction. Momentum is strong, sentiment is bullish, and the fundamentals are healthy. Thus, this stock should remain a winner for the foreseeable future.
But Don’t Expect $200 Anytime Soon
Although strong numbers can keep Lululemon stock on its winning path, they won’t push it to $200 anytime soon.
After all, the stock is trading at more than 40X forward earnings. The king of this segment, Nike, trades at 30X forward earnings. The ugly duckling of this industry, Skechers, trades at 15X forward earnings. The whole apparel retail sector trades at under 20X forward earnings.
In other words, Lululemon already has a big valuation. And while growth is big, it isn’t that big. Long-term earnings growth estimates hover around 20%, meaning the stock is trading at more than double its long-term earnings growth potential.
The market, by comparison, is trading in-line with its long-term earnings growth rates, while the consumer discretionary sector is trading at a 10% discount to long-term earnings growth.
Broadly speaking, LULU stock is already expensive. The stock is below $160. At $200 by the end of the year, Lululemon would look ridiculously expensive.
Instead, I think an appropriate year-end price target for Lululemon stock is $160. This company will never get to Nike or Adidas size. Those companies have a global presence across the whole athletic apparel scene, including the highly lucrative basketball and soccer markets. Lululemon doesn’t have that, and it doesn’t aspire to, either. As such, dreams of $20 billion-plus in revenues are silly.
Instead, a reasonable medium-term goal for Lululemon is to get to Under Armour and Skechers size, so around $5 billion or more in sales. Assuming the company can get there in five years, and that profitability continues to improve due to strong brand image, I think Lululemon can net earnings per share of roughly $8.50 in five years.
At that point in time, LULU stock should trade at a Nike-type multiple. Nike’s five-year average forward earnings multiple is 25x. A 25x forward multiple on $8.50 implies a four-year forward price target of ~$213. Discounted back by 10% per year, that equates to a year-end price target of $160.
Bottom Line on Lululemon Stock
Lululemon is on fire, and the company’s recent successes will persist for the foreseeable future as this company transitions from niche to mass market. Operational excellence will keep Lululemon stock on its upward trajectory. But, pipeline dreams of $200 and up prices within the next 12 months seem silly, considering the stock is already expensive at $160.
Investment takeaway? Stick with Lululemon below $160. But, don’t get too greedy. This stock will likely hit $200, but not for another three to four years.
As of this writing, Luke Lango was long SKX.
More From InvestorPlace
- 10 Best Blue-Chip Stocks for Mid-Career Investors
- 7 Market Heavyweights to Ditch Before the Selloff
- 5 Stocks to Buy Amid a Prolonged Trade War Slump
- 3 Trade War Stocks to Buy (and 3 to Sell)
The post Lululemon Stock Is a Winner, but It Won’t See $200 Anytime Soon appeared first on InvestorPlace.