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10/17/16 10:00:10 AM



This week's Focus Stock of the Week is Lululemon Athletica Inc. (LULU: $56.62), which carries CFRA's highest investment recommendations of 5-STARS, or Strong Buy. The company is a specialty retailer and marketer of technical athletic apparel under the lululemon athletica and ivivva athletica brand names. Its offerings are mainly targeted to women who are inspired by the healthy lifestyle, with an expanding product line for men, and female youth.

As of January 31, 2016, its retail footprint included 363 company-operated stores, mainly in the U.S. (229), as well as Canada (48) and Australia (26), with the rest (60) located New Zealand, U.K., Singapore, Hong Kong, Germany and Puerto Rico. LULU has three reportable segments, namely, company-operated stores (74% of revenues and 67% of total segment EBIT in FY 16 (Jan.)); direct-to-consumer (19% and 32%); and other (7% and 1%). The breakdown of FY 16 revenues by geographic regions were: U.S., 73%; Canada, 20%; and others, 7%. The company completed its IPO in July 2007.

While the company significantly benefits from the growing number of people that participate in yoga, it believes the percentage of its products sold for other activities will continue to increase as it broadens its product assortments. To this end, and pursuant to a long-term financial goal to double its revenue and more than double its earnings by 2020, management recently articulated some key elements of its long-term growth strategy.

First, LULU aims to stay focused on product innovation, as it builds its women's sweat category and improving its tops business (as well as bottoms). Second, it plans to further build out its store base in North America, while targeting a double digit growth in global selling square footage over the next few years. Next, it plans a continued ramp-up of its digital business (partly on e-commerce growth), targeted to reach 25% to 30% of total revenues by 2020. Lastly, the company plans a continued expansion in Asia and Europe, as it expects international markets to reach 20% to 25% of its total revenues by 2020, and be accretive to earnings by the end of 2017.

We expect total revenues to increase approximately 14% in FY 17 (Jan.), to about $2.34 billion and notably within management's target range. This assumes a mid-single digit growth in comparable sales (in constant currency), partly on increased traffic as well as higher average unit retail prices. Also, we note management's plans to open about 42 new stores in 2016 - including 11 international stores and 12 ivivva locations - for a targeted square footage growth of about 12%. With an ongoing stores expansion, we project 13% revenue growth in FY 18.

After fiscal Q2 results that saw a notable positive inflection in product margins and strong gains in the nascent e-commerce and men's businesses, the company slightly raised its full-year financial targets, with an expected acceleration in the second half. We project operating margins of 17.7% in FY 17 - a modest contraction versus 17.9% in FY 16. Even so, this assumes a significant improvement in product margins (on lower input costs and reduced promotional markdowns) and higher SG&A expenses (on higher employee costs and stores pre-opening expenses), as well as investments in IT and brand marketing). Nonetheless, with expectedly incremental benefits of recent supply chain improvements, we see margins improving to 18.5% in FY 18. After taxes, and noting a recently completed $450 million share buyback program, we forecast EPS of $2.12 in FY 17 - versus FY 16 normalized EPS of $1.86 - further advancing to $2.51 in FY 18.

We see attractive upside for the shares at current levels. Our 12-month target price is $78, on relatively ample forward P/ E of 31.1X on our FY 18 estimate, a notable premium to peers but markedly below the stock's five-year historical average of 42.6X. We think LULU's premium versus peers is partly warranted by its well above-average EPS growth prospects - projected in the mid- to high-teens percentage range. With no debt and ample liquidity, we believe the company has sufficient liquidity and financial flexibility for its ongoing capital initiatives.

We highlight some potential risks to our recommendation and target price. These include a potential inability to execute on global expansion; market share losses against larger (and more popular) athletic brands; conceivably lackluster customer response to new product assortments; a sharp macroeconomic slowdown in overall consumer spending.

CFRA's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.


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