One path to success in investing is to purchase shares of solid, well-run businesses and hold them over the long term. Growth stocks offer the prospect of long-term capital appreciation that can help you achieve your big-picture financial goals. Characteristics investors should look for in a company include sustainable tailwinds for the business, a stellar management team with strategic vision and focus, and a track record of steadily growing profits and free cash flow.
Even stocks with such attributes, however, are not immune to periodic bouts of market pessimism. With investors closely monitoring every quarterly result and comparing it with analysts’ expectations, there are times when even the shares of strong companies get sold down sharply. Investors should view such events as opportunities to scoop up shares on the cheap — if the company’s fundamentals are still solid.
Lululemon (NASDAQ: LULU) is one such stock. Its share price has tumbled by 40% year to date. Let’s examine the reasons for this decline, and why the stock is looking increasingly attractive.
Weak demand from North America
Lululemon’s recently released fiscal 2024 first-quarter report disappointed investors. For the period, which ended April 28, the athleisure apparel company’s revenue increased 10% year-over-year to $2.2 billion, with comparable sales rising by 6%. In North America, however, demand was weaker: Sales rose just 3%, a sharp slackening from the 17% growth a year prior. Comparable sales in North America were flat.
CEO Calvin McDonald attributed the North American underperformance to weaker demand, but acknowledged that Lululemon had fumbled by having an overly narrow color assortment. Moreover, it had not ordered enough of the products customers did want in the sizes they required. As a result, customers too often found that the items they sought were out of stock.
Management also issued weak guidance for its second quarter, but said it expects business conditions to improve in the second half of the year as it works to rectify its earlier errors. On a brighter note, Lululemon still reported a 10.7% year-over-year jump in net income to $321.4 million.
The chief product officer exits
In news that added to investors’ pessimism, Lululemon also announced the departure of Chief Product Officer Sun Choe in late May. Choe had held the role for seven years and was responsible for Lululemon’s expansion into footwear. She was also in charge of launching the company’s men’s footwear series earlier this year and was viewed as an integral part of Lululemon’s innovative designs and releases. The company will not seek a replacement to fill her former position; instead, it has announced a more integrated organizational structure under which it will pursue its long-term goals and spearhead product innovation.
Jonathan Cheung, the current global creative director, will report directly to the CEO and be responsible for product design, innovation, and development. A new team will be created consisting of top staff from the company’s merchandising and brand divisions to help scale the business into international markets.
Consistent net income growth with free-cash-flow generation
Despite the weaker fiscal Q1 results and the loss of Choe, there are reasons for optimism. Lululemon has grown steadily over the years, and is also a veritable free-cash-flow machine. Its revenues more than doubled from fiscal 2019 to fiscal 2023, soaring from $4 billion to $9.6 billion — a compound annual growth rate (CAGR) of 24.7%.
Net income also shot from $646 million to $1.55 billion over the same period, for a CAGR of 24.5%. Lululemon also generated an average positive free cash flow of $785 million for these five fiscal years. What’s more, the athleisure company managed to keep its balance sheet free of debt, thus insulating itself from the impacts of surging interest rates over the past two years.
The Power of Three x2
Lululemon announced a new set of strategic goals back in April 2022 aptly titled “The Power of Three x2.” This updated set of targets was a follow-up to Lululemon’s first Power of Three plan, which it debuted in 2019. The company successfully met the goals of that first plan and nearly doubled its revenue from $3.3 billion in 2018 to $6.25 billion in 2021. Management’s current ambition is to double its 2021 revenue to $12.5 billion by 2026 by focusing on the same three key pillars — product innovation, guest experience, and market expansion.
Lululemon also has set a goal of doubling the revenue from its menswear segment from its 2021 level by 2026 by leveraging its Science of Feel technology to innovate across the apparel and footwear categories. In addition, it aims to double its digital revenue by 2026 by building connections across both physical and digital stores, and nurturing its community of loyal customers. An effective tool in that effort is its membership program, which offers benefits such as early access to product drops, receipt-free returns, and free hemming.
The third goal is to quadruple international revenue over the same period by entering new markets such as China, Southeast Asia, and Europe. Lululemon is on track to achieve this — international revenue in fiscal Q1 surged 35% year over year as comparable store sales grew by 25%.
A growing market for athleisure products
The growing market for athleisure wear and products will provide tailwinds for Lululemon as it pursues its objectives. The athleisure market was valued at $358 billion last year, according to Grand View Research, which projects that it will grow at a compound annual rate of 9.3% through 2030 to hit $667 billion. Lululemon can ride on the coattails of this trend to grow both its top and bottom lines, with its international push being an important growth catalyst.
Lululemon has traded above 40 times earnings for most of the past decade, but shares look cheap now at around 24.7 times earnings. Investors who believe in the strength of this brand and are confident in the company’s long-term future should consider taking a stake in Lululemon now or adding to their positions.
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Royston Yang has positions in Lululemon Athletica. The Motley Fool has positions in and recommends Lululemon Athletica. The Motley Fool has a disclosure policy.
1 Growth Stock Down 40% This Year to Buy Right Now was originally published by The Motley Fool
