lululemon athletica (NASDAQ: LULU) has been one of the best growth stocks around lately. The shares are up 90% over the past year and currently sit at a forward price-to-earnings multiple of 37 based on this year’s earnings estimates. The stock has risen 15% since the company delivered another round of robust growth for the fiscal fourth quarter in late March.
Investors are impressed by the company’s momentum and are counting on the yoga apparel brand to keep up the rapid pace of growth to justify the high valuation. Here are two areas to watch that could keep Lululemon’s earnings growing at a fast clip.
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Building scale through international growth
One of the most impressive trends in Lululemon’s business is the explosive growth happening internationally. In the last quarter, Asia and Europe grew more than 70% and 55%, respectively, representing an acceleration in both regions over the previous quarter.
The international momentum is partly due to management’s aggressive store expansion strategy. On previous conference calls, management has pointed out the tremendous interest in the brand it sees in China. In 2018, the company opened a total of 36 stores, with most of those outside the U.S. and Canada.
International revenue is still small compared with the company’s total revenue, but as it grows in size, the international business is starting to reach the scale that could have a significant impact on margin. Stores in Asia have reached a tipping point at which higher sales volume and productivity are allowing the Asia business to deliver a profit. The business in Europe is currently losing money, but management expects Europe to reach breakeven within the next 18 months.
What’s more, as Lululemon expands around the world, the company is able to diversify its supplier base, which allows for better pricing on materials. Lululemon is also gaining greater visibility into product costs as a result of closer relationships with existing vendors. It’s for these reasons that management guided for continued improvement to gross margin in 2019.
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Digital growth juicing margins
Another catalyst for strong earnings growth is booming digital sales, which now represent nearly a third of Lululemon’s total revenue.
Lululemon’s digital operation is one of the most profitable in the retail industry. In 2018, the direct-to-consumer channel, which includes online sales, generated an operating margin of 41% while the company’s physical stores had a margin of 27%. As long as digital sales keep increasing as a percentage of total revenue, margin should continue to move higher and fuel earnings growth.
Digital sales growth will play a key role in improving margin internationally. Management believes digital penetration in Asia will reach 50% in the long term. That estimate could prove conservative, considering how comfortable the Chinese are with shopping online. Also, Lululemon plans to launch new websites in France and Germany, which is expected to “dramatically improve” digital engagement with customers. Keep in mind, Lululemon saw a dramatic acceleration in digital sales in 2018 after reworking the website for the North American market.
Lululemon is growing fast, but management continues to emphasize areas where they can still do better. There are still opportunities to enhance efficiencies throughout the supply chain. There are also areas on the digital side where management believes it could improve, such as in digital marketing and making the website better.
In the most recent quarter, Lululemon’s e-commerce revenue increased 37% year over year, and 140% year over year in China. Lululemon saw its gross margin inch into the high 50s over the past year, and that improvement happened with the drag coming from lower profitability in the international business, especially in Europe.
The stock trades at a high valuation of 46 times last year’s earnings. I don’t know what the stock will do the in the short run, but with profitability on the rise in Asia and Europe, and the digital business continuing to grow fast, Lululemon should remain a great growth stock for the next five years and beyond.
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John Ballard owns shares of lululemon athletica. The Motley Fool recommends lululemon athletica. The Motley Fool has a disclosure policy.
