Lululemon: The retailer that can’t stop rallying

Friday saw shares of Lululemon Athletica Inc NASDAQ: LULU surge more than 5% after the company reported its Q3 earnings. The athleisure retailer smashed analyst expectations on both headline numbers, with EPS coming in 10% higher than expected and revenue showing year-on-year growth of 18%. Gross profit was up 21%, with the company’s gross margin also rising up to an impressive 57%. 

The results were released after the bell rang to end Thursday’s session, and, considering the headline beat, the initial reaction in the after-hours sessions was negative. Shares fell about 5% off the back of weaker-than-expected forward guidance, which tends to weigh on any positivity from the rest of an earnings report. 

Specifically, Lululemon’s team is anticipating Q4 revenue to land between $3.135 billion - and $3.17 billion, slightly below the consensus estimate of $3.18 billion. Similarly, the projected EPS for the holiday quarter is expected to be in the range of $4.85 to $4.94, also below the consensus estimate of $4.94. 

Surprise reaction

However, as seen in Friday’s session, Wall Street has been quick to shake off any initial concerns about a slowdown in growth. The stock surged through the day and hit an all-time high shortly before Friday’s close. Having previously fallen almost 50% from 2021’s all-time high, Friday’s move was the latest in what’s turning into a stunning multi-year rally. Lululemon shares have effectively now doubled from their post-selloff low as shares continue to trade more like tech stocks than traditional retailers. 

Looking ahead into 2024, it’s hard not to be bullish, given the strength of the reaction to Thursday’s report. Investors would have been well within their rights to reduce their exposure and watch from the sidelines, but a surge like that seen on Friday points to there being huge demand on those same sidelines. Already, we’re seeing a host of price target increases from the analysts, with the likes of Oppenheimer now looking for shares to hit $540. 

It’s likely that management’s decision to boost its stock repurchase program by $1 billion went a long way to removing any guidance-related concerns. This is something a company only does when it feels that its shares are trading so far below its own calculation of fair value that they’re willing to buy them themselves. It’s also a bullish signal to the market about management’s own conviction in its ability to continue executing and delivering growth. 

Some caution needed

The stock doesn’t come without its risks, however. Last week saw the team at Raymond James urge some caution as they downgraded their rating on Lululemon from Strong Buy to Outperform. Their stance is obviously still bullish, but Friday’s pop means Lululemon shares are already basically trading at Raymond James’ refreshed price target of $495. 

The team at Wells Fargo took a similar view last week ahead of the report when they downgraded Lululemon shares from Overweight to an Equal Weight rating. They felt it was a good time to take some profit off the table, and in many ways, considering the weaker-than-expected forward guidance, they were right. Few would have predicted that the company’s shares would have reacted as they did in spite of this, so any investor considering getting involved should be aware that things are starting to look a little frothy. 

At 62, Lululemon’s price-to-earnings ratio has nearly doubled in the past year, while the stock’s relative strength index is approaching 80. This latter reading indicates extremely overbought conditions, so unless you’re uber bullish, it might be an idea to gradually scale into a position for now versus going all in. It wouldn’t be all that surprising for some volatility to creep into shares in the coming sessions, and while the outlook remains bullish, there could soon be some better prices on offer.

It will be interesting to see how things play out in the coming weeks as the holiday season gets into full swing. Lululemon remains a very likely candidate for any growth-focused portfolios heading into 2024, but those getting involved may need an iron stomach in the short term.