lululemon Athletica (Nasdaq:LULU): Good Numbers +18%

Lululemon given signs of healthy demand at retail, an aggressive inventory posture and new product introduction strategy, and likely benefits from heightened visibility with prominent exposure on Oprah, we see potential for upside to our 3Q estimates and remain comfortable with our above-consensus 4Q estimates. Our model is for 3Q constant currency comps, revenue, and EPS of 18.5% (16.5% reported), $157.4M, and $0.26, versus consensus for 19.2%, $159.3M, and $0.25.

Aggressive inventory posture, pace of new product introductions in store positions firm well for Holidays, in our view. Our visit to 15 stores over the course of the quarter suggests: 1) Limited discounting within the quarter; 2) Healthy in-stocks, particularly late in the quarter, with store staff noting an uptick in inventory deliveries (and not deceleration of demand); and 3) A solid pace of new product introductions. Our visits to lululemon.com over the course of the quarter suggest limited clearance inventory availability via the "We Made Too Much" section of the site, providing support for our qualitative in-store checks.

Increasing visibility of brand suggests catch-up of U.S. stores to Canada level productivity may be more rapid than we had been anticipating. Given signs of heightened visibility of the concept in the Untied States, as evidenced by the Oprah mention and a 50%-plus uptick in U.S. Google searches for "lululemon" over the prior year this holiday season (source: Google trends), we expect catch-up of U.S. stores to Canada-level productivity could prove faster than we previously anticipated. We currently model for 10% comps at lululemon stores in 2011 and 7.5% comps in 2012. This is well above our expectation for 3-5% industry growth in the apparel market over the next 2 years. Our model suggests that Canada generates $6.6M in revenue for each store in the region, while the United States only generates $4.7M in revenue for each given store.

Remain concerned that current valuation sets the bar too high for 2011 performance. While we remain compelled by the potential for sustained door expansion and comp store sales growth, we are challenged to justify current valuation, which implies 36x our above-consensus EPS estimates for $1.53 (consensus $1.47). In our view, support for shares at (or above) current levels, would require FY11 EPS approaching $1.75 (assuming a 32.5x multiple is sustainable,) requiring 15-20% comps and 100-150bp of operating margin expansion. We view this as unlikely given: 1) more challenging comparisons; 2) rising product costs, which are likely to pressure initial margin; 3) high likelihood of accelerated (initially dilutive) store openings; and 4) required investments in infrastructure and headcount.

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