It was a strong one for the holiday season Lululemon Athletica (Lulu 1.58%), although pricing weakened in early 2023. The company’s recent earnings update was full of good news about the business, such as strong customer traffic momentum. On the other hand, a surprising decline in gross profit margins has Wall Street worried that the good times may soon be over.
With those concerns in mind, here’s a look at whether Lululemon stock is a compelling buy in early 2023.
Latest update
The company’s January 11 operating update showed a mixed performance through the end of 2022. The sales trend has held up well, and in fact, the company has raised its revenue target for the full year.
Sales should now land between $2.66 billion and $2.7 billion, which translates to a roughly 26% year-over-year spike. The previous forecast range was $2.6 billion to $2.66 billion. “We are pleased with our continued revenue growth and the momentum in our business,” CEO Calvin McDonald said in a press release.
Symptoms of stress
There were signs of stress, though. Lululemon lowered expectations on gross profit margins, implying pricing pressure in early 2023. The company reported an increase in inventory levels late last year, but management said the spike did not reflect weak demand from athletic shoppers or greater price sensitivity. But the decline in gross profit margins shows that Lululemon has struggled to overcome all the rising costs currently impacting the business.
LULU Gross Profit Margin data by YCharts.
A key part of the investment thesis for Lululemon stock hinges on the chain’s industry-thumping profit margins. Above many peers with gross margins Nike (No 1.68%), and has been steadily increasing since before the pandemic hit. A change in that trend would threaten shareholder returns by erasing some of the premium valuations Wall Street assigns to stocks.
No cause for concern yet. The company is seeing a rapid spike in costs, and it makes sense that this increase will temporarily pressure gross margins. Lululemon is also finding room to cut costs in other areas, and so its operating profit margins are higher than most of its retailer peers.
Still buying one
Investors have some good reasons to temper their expectations for 2023, given the slowdown in consumer spending and the possibility of a recession on the way. Lululemon’s high inventory levels and declining gross profit margins represent additional risks that suggest weaker sales and earnings ahead in the short term.
That doesn’t change the broader bullish thesis for the stock, though. Lululemon is still finding a lot of excitement for its new product releases, which are increasingly moving into new geographies, new markets and new categories such as outerwear and footwear. Its sales growth and operating profit margin metrics are far above what investors can find with most of its industry peers.
Lululemon won’t be immune to a slowdown or a sharp pullback in consumer spending, should it develop over the next few quarters. But its latest operating update does not describe such a slowdown. On the contrary, the company has a good shot at seeing another year of growing sales and improving profits in the long run. These positive factors place the stock firmly in the “Buy” category.
Dimitri Kalogeropoulos has a position at Nike. The Motley Fool has positions and recommends Lululemon Athletica and Nike. The Motley Fool recommends the following options: Long Jan 2025 $47.50 Nike call. Motley Fool has a revealing policy.