June 1, 2020
LULU Rally Unjustified
Lululemon has seen an upward trajectory recently increasing from $220 to $305 per share in less than a month. Earnings are fast approaching and due for release Thursday, June 11 where investors will get insight on the impact of COVID 19 sales. It is hard to justify this pandemic having a positive spin on LULU sales as unemployment spikes, malls shut down, and businesses such as dance and yoga close doors in efforts to contain the virus spread.
LULU primarily operates in athletic apparel for men, woman, and youth. It is worth noting the company is well managed and has seen descent revenue growth and earnings the past 5 years. How ever, COVID 19 has resulted in a global slow down and overnight shuttered brick and mortar stores which Lulu operates. During times of uncertainty I expect consumers to make rational spending decisions which include holding off on large purchase items and expensive athletic wear. If this holds any bearing then expect apparel companies to offer discounts in order to maintain sales quota. This would impact margins and result in lower earnings. So why has the company increased 38% in the past month and currently trades at all time highs?
Investors could be looking at growth in online sales, which should do well as people distance themselves working from home and ordering online. True, online sales should grow but in store sales will slow, which does not justify a 38% increase in share price. Are investors optimistic of a quick economic recovery? The reality is many are still struggling to get by these uncertain times, both businesses and families. Perhaps LULU stock was just undervalued? LULU currently trades at a huge premium to the likes of larger sport apparel companies such as Nike and Adidas. The price to earnings ratio currently sits at 60, significantly higher than the 33-35 range of the other two. I’ll also add that LULU does not pay a dividend and only sees 10-20% the revenue of Nike and Adidas.
What is the best way to play LULU heading into earnings?
Given my belief LULU appears over valued and is due for a correction below $300, writing call premiums at or in the money appear to be good risk/reward. With the stock trading at $305, June 12 Calls @ 305 strike show a premium of $15.65. I don’t expect much more significant movement to the upside, providing an opportunity to hold the options for more than a week and allow Theta to price the options accordingly. If the shares continue to climb, at current premiums this would provide a break even at $320.65.
At the time of writing this article I currently am short call options in LULU.