Price action, especially to the downside, can be scary for some investors. However, a price chart is only part of the real story. After declining more than 35% from its all-time high, Lululemon Athletica Inc. (NASDAQ: LULU) looks like a dip investors could consider today.
A stock's price is relative, but its price-to-earnings (P/E) multiple is a more reliable valuation. And Lululemon's 27.8x multiple places it back to 2017 levels, despite having grown its underlying earnings per share (EPS) by more than four times. Now that the Federal Reserve (the Fed) chairman Jerome Powell has scared markets by potentially delaying interest rate cuts even further, the consumer discretionary space is on the retreat.
Over the past 12 months, Lululemon stock underperformed the Consumer Discretionary Select Sector SPDR Fund (NYSEARCA: XLY) by as much as 25%. Despite being one of the more substantial brand names in the apparel industry, Lululemon is now at a considerable discount and has quite a bit of ground to cover to catch up to the pack.
Why the Bear Face?
Lululemon's sell-off came from market-wide disappointment, not a company-specific issue.
The Fed had proposed up to four interest rate cuts this year, the first of which could have been as early as March. According to the CME's FedWatch tool, these potential cuts have been delayed as far as September 2024.
The market had to settle with the assumption of three cuts instead of the initial four proposed at the beginning of the year. Because the consumer discretionary space – and the U.S. consumer – is highly dependent on financing, this disappointment may have caused Lululemon to fall. Commercial banks like Citigroup Inc. (NYSE: C) and Bank of America Co. (NYSE: BAC) reported increasing losses in their credit card departments as an inflation-choked consumer has had to rely on credit to keep up with living expenses.
Fearing a consumer tipping point, traders may have looked to cut risk by unloading Lululemon shares. However, U.S. consumer sentiment is now at a three-year high, and The Goldman Sachs Group Inc.'s (NYSE: GS) quarterly report shows that interest rate cuts could be just around the corner.
Lululemon Still Rocks the Market
Investors can gauge the market's sentiment toward Lululemon stock, keeping its recent decline outside the equation. To do this, two things must be considered: earnings per share (EPS) projections and how these future earnings are valued today.
Compared to the broader apparel industry, Lululemon is a standout stock. But instead of looking at all the names, why not stick to the next best thing: Nike Inc. (NYSE: NKE). Nike analysts think the company could push out 6% EPS growth in the next 12 months, and markets slapped a forward P/E multiple of 23.6x on these projections. A 23.6x P/E is 123% above the apparel industry's average valuation of 10.6x forward P/E.
Every value investor knows it is quite alright to pay a premium valuation for a stock that carries a more robust brand or product moat, which are requirements that Nike and Lululemon satisfy.
This is where it gets interesting. Lululemon is set to grow its EPS by 12% this year, twice the rate of Nike. At the same time, markets value these future earnings at a comparable forward P/E of 21.2x, only 10% below Nike.
In its latest quarterly earnings report, Lululemon announced 16% annual sales growth and 20% EPS growth. Even if the United States does see a weaker consumer this year, 12% EPS growth projections lie on the more conservative end of the spectrum. More than that, even if markets did wrongly price in these potential rate cuts, Lululemon's revenue growth mainly came from international sales. A weaker U.S. consumer could be cushioned by international momentum to take its place.
For these reasons, analysts see a consensus price target of $485.39 in Lululemon, calling for up to 43% upside from today's prices. As the ISM manufacturing PMI index data suggests, the apparel industry is far from slowing down. After contracting for November and December 2023, the industry extended for two consecutive months in January and February 2024.
Knowing this dip is one of the best potential opportunities today, the Vanguard Group boosted its position in the stock by 32.3% in the past quarter, bringing its total investment up to $4.96 billion.
