In late October, we suggested that Lululemon (LULU) was a favorable alternative to Nike, given its low valuation and better revenue trajectory. Since that time, Lulu has materially outperformed. We have a new way to play the stock from here. Sine that initial call, Lulu shares gained about 7% through last Friday, versus a 4% total return of the S & P 500 and flat performance for Nike. A common mistake investors make is taking profits too early, ignoring the old investment adage “let your winners run.” Still, as Lulu’s quarterly earnings report approaches Wednesday after the bell, investors may be concerned that the stock could give back its recent outperformance. The good news: Some of the bull thesis we outlined five weeks ago remains true today. At 21.7 times forward earnings estimates, Lulu is cheaper than several athletic apparel competitors, such as Nike (26.1x), Under Armour (26.8x), Adidas (30.6x), and VF Corp (25.5x), as well as the consumer discretionary index (~29x) and the S & P 500 (25.5x). The Bad News: Observed Q3 sales compiled from a sample of credit and debit card purchases are underperforming the consensus estimates for the period. On the chart below, see the year-on-year sales growth (declines) from the observed sample in blue versus the estimates in red. Conclusion: In fairness, the observed data for the entire group is poor, and Lulu’s numbers are generally better than its competitors. Slowing growth rates or weakness in consumer discretionary spending shouldn’t surprise us as most data, including consumer debt and delinquency rates, suggest that many consumers are stretched even before the heavy spending typical during the holiday season. Lulu’s more affluent demographic may account for the observed relative outperformance to the group. While sell-side analysts’ estimates have probably averaged about 50bps too high relative to the observed data, it is common for that data to trail slightly. Still, I am concerned that sales may have fallen in the second half of the quarter relative to the same period a year earlier. There’s a big difference between a company growing less quickly and shrinking. Right now, the options market implies a about a $30 move in the stock price, higher or lower, by the end of this week. Rather than continuing to hold the stock, an investor looking for slightly less risk could use a stock substitution strategy through earnings. The trade: Stock substitution strategy A stock substitution strategy is an…
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