Althom
The past few years have been amazing for Lululemon (NASDAQ:LULU). The company achieved mesmerizing growth as its loyal customer base swelled. Even as the economic growth slowed in 2022, Lululemon’s growth has been persistently strong clearly showing the tailwind from brand loyalty growth. The tailwind will likely continue in the coming years, however, ahead of the 2022Q3 earnings report on December 8th, I believe investors should be more cautious. Headwinds that have been facing the company are getting increasingly stronger to the point where it is becoming stronger than the company’s tailwind. Lululemon stock valuations are slowly pricing for perfection while the macroeconomic conditions affecting consumers are getting worse.
Excitement
Excitement for Lululemon’s future performance has been building up in recent weeks.
It is a well-known fact that Lululemon is popular, especially among teens and younger generations, and Piper Sandler’s semi-annual research has confirmed this fact. According to the research, Lululemon was the second most popular clothing brand behind Nike (NKE). Further, in the clothing brand segment, Lululemon and Nike were the only athletic clothing brands potentially indicating a duopoly in popularity. With few popular competitors, Lululemon is set to benefit. On top of the strong popularity of the brand, Morgan Stanley (MS) estimated that Lululemon was one of the biggest winners of the Black Friday holiday sales.
These reports have likely created excitement around the stock as these data points suggest an opportunistic future for Lululemon. The brand’s popularity among younger generations today will likely create a continuously swelling loyal fan base as a consumption spending trend is created, and younger generations are more sensitive to trendy and popular things. If an increasing number of your friends are seen with Lululemon, you will likely buy Lululemon in the future. Further, a report that Lululemon has likely had strong holiday sales in times of slowing macroeconomic conditions and concerns surrounding consumer spending has created further optimism surrounding the stock. As a result, Lululemon’s market capitalization increased 36.58% from its lows on September 30th creating a market capitalization of $46.33 billion with a valuation multiple or forward price-to-earnings ratios of about 38.
Pricing for Perfection
I believe the positive recent news may have priced Lululemon for perfection. Investors are not only expecting great results for the 2022 Q3 earnings report, but investors are also expecting strong guidance into what may be a challenging 2023, which is shown in Lululemon’s high valuation and a recent sharp increase in the company’s market capitalization.
I believe Lululemon’s current valuation is not cheap with a forward price-to-earnings ratio of about 38 due to the impending macroeconomic headwinds. The U.S. is expected to enter a recession in 2023. The manufacturing output, which often is affected by the current economic state, shown in ISM Manufacturing Index has already started to contract at 49% in November (50% represents the status quo while below 50% represents contraction). Further, because the International Monetary Fund is continuing to downgrade world economic growth expectations in 2023, it is possible that the likelihood of a recession and its depth may continue to worsen.
The consumer spending outlook, as a result, is not bright. In 2022, consumer spending is expected to grow 2.5% year-over-year before significantly slowing down to 0.9% in 2023. On top of the slowing consumer spending expectations, Lululemon’s products are discretionary. When the economic conditions are tougher, discretionary items are one of the first cuts a consumer makes. This, I believe, is especially true for Lululemon because the company operates in the premium market. There are so many other cheaper alternatives.
I believe the macroeconomic headwinds are getting stronger going into 2023, which may offset or be stronger than the tailwind that has been created from the strong brand popularity. Therefore, Lululemon’s current valuation and strong future expectations may pose risks for investors.
Risk to Thesis
Some investors may argue that Lululemon will continue its strong growth into 2023 because of the brand’s increasing popularity as the company will take market share away from its competitors. Further, because Lululemon is a premium brand, its primary customers are less likely to be swayed by macroeconomic downturns. While these arguments may prove to be true, my views are slightly different.
The full effect of the Federal Reserve’s aggressive interest rate increases has not taken effect yet. It takes about 6 months or more for ordinary consumers to feel the damage, even relatively high-income consumers. American Express (AXP) has high-income customers relative to its competitors like Lululemon, and although it is true that the company has a lower delinquency rate than its competitors, American Express is preparing for a riskier 2023. The company shocked the market with higher-than-expected provisions for credit losses in its latest earnings report, signaling that even relatively higher-income households are not immune to recessions. As such, I believe Lululemon’s high-income customers will not be enough to completely shield the company from the impending storm.
Summary
In the long term, Lululemon may grow to be a much bigger company leveraging its popularity among younger generations. However, in the short to mid term, the headwinds facing Lululemon are growing stronger. Recession possibilities and consumer strength may create a significant hurdle going into 2023 in times when investors are expecting a rosy outlook. Therefore, while the future may look bright for Lululemon, it may be favorable for investors to be cautious of the worsening macroeconomic headwinds and valuation risks ahead of the upcoming earnings report.
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