Growth Stock Could Zoom Again After Settlement of Key Patent Case: It Ain’t a Smart Phone

The settlement of a much-watched battle over allegations of infringement of a design patent may well clear the way for the stock of a former market darling to return to and possibly exceed its recent stratospheric highs. No, I’m not referring to Apple (AAPL) and its war against Samsung, but to a squabble over – of all things – the design of a $98 pair of yoga pants sold by Lululemon Athletica (LULU). Lululemon sued fashion design firm Calvin Klein, claiming that the latter had copied three of its patents for the “Astro Pant”, including one for a distinctive waistband design. Late last month, the companies settled the suit (the terms weren’t disclosed).

LULU PE Ratio TTM Chart

LULU PE Ratio TTM data by YCharts

Lululemon is one of those high expectations stocks that trades at a hefty premium to the S&P 500, in large part because the company’s earnings are growing far more rapidly. Its PE ratio – it trades at 47.42 times earnings – is enough to scare off all but the most avid growth investor. But the company reported in September that its net income jumped nearly 50%, trouncing analysts’ forecasts and prompting it to raise its earnings guidance for the year. Now analysts are holding their collective breath, waiting for the company to report its results for the fiscal third quarter tomorrow. The consensus is that it will be another big quarter, with analysts predicting earnings of 37 cents a share, up from 27 cents in the year-earlier period.

LULU Gross Profit Margin Quarterly Chart

LULU Gross Profit Margin Quarterly data by YCharts

Lululemon’s profit margins have come down from their recent peak last year, but appear to be stable even as earnings growth rates remained robust. Some analysts even suggest that the apparel company has actually “under-earned”, leaving some demand unmet because its products sell out so rapidly. That’s the view of Canaccord Genuity analyst Camilo Lyon, who a few days ago initiated coverage of the company with a “buy” rating, setting a price target of $91 a share, well above its current price of about $71. Lyon suggested that manufacturers are increasing production of Lululemon garments, that the brand’s online sales channel can deliver more earnings and that international growth is in its infancy. Overall, he concluded, Lululemon is evolving from being a niche athletic wear company into a lifestyle brand.

Of course, there is the matter of that premium valuation, in the form of a PE ratio that is triple that of the S&P 500. But these days, that may be the price that investors have to pay for success in the form of earnings growth. After all, earnings growth for S&P 500 companies has been declining and may not even end the third quarter of 2012 in positive territory. Lululemon’s same-store sales were up 15% in the second quarter, while a year-to-date monthly average for the big retailers in the Thomson Reuters Same Store Sales Index was only 4.3% as of the end of November.

Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post.

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