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Some investors might have thought lululemon athletica‘s (NASDAQ:LULU) e-commerce business couldn’t get any better than the fiscal first quarter, but it did. E-commerce sales accelerated again to a triple-digit growth rate and made up 61% of total revenue during the fiscal second quarter. That is up from 25% in the year-ago quarter.
Management sees e-commerce growth remaining at elevated levels, though not as high as the recent quarter, which could be beneficial to Lululemon’s bottom line beyond COVID-19.
Online demand is off the charts
For the quarter, total revenue increased 2% year over year, driven by an impressive 157% increase in e-commerce sales. Excluding a warehouse sale during the quarter, e-commerce still grew 137%. Lululemon also saw strength in full-price sales, which kept product margin flat year over year.
During the fiscal second-quarter conference call, CEO Calvin McDonald said: “2020 is likely an inflection point for retail and for lululemon, with certain changes in guest behaviors likely to endure in the post-COVID-19 world.”
McDonald discussed several things the company is doing to prepare for online demand that is expected to remain above the pre-COVID growth range of 30% to 40% going forward.
“We are prioritizing spending on digital and omni initiatives and fulfillment capabilities while pulling back somewhat on new store openings and remodels,” he said.
Specifically, management called out site enhancements, IT investments, distribution center capabilities, and growing the ranks of omni educators to prepare for a potential spike in online sales during the holiday quarter.
McDonald explained that these were areas Lululemon was planning to invest in over the next two years, but the acceleration in e-commerce has caused it to pull forward these investments.
Lululemon is well positioned to benefit from the shift in consumer behavior to working from home, exercising from home, and active lifestyles. McDonald said: “These trends play to our strengths and set up an opportunity for us to continue to innovate and gain market share.”
Online sales generate high margins
Faster e-commerce growth presents a catalyst for improved profitability, which would lead to a boost in earnings growth, once the business has fully recovered from COVID-19. Last quarter, adjusted earnings per share came in at $0.74, below the $0.96 reported in the year-ago quarter, but still a healthy profit, given the stores that were closed at the beginning of the quarter.
The e-commerce business generated an operating profit margin of 43% over the last two quarters. That is substantially higher than the typical operating margin of 25% for sales made in a store. Lululemon’s stores were unprofitable the last two quarters due to store closures, which means the company’s entire profit so far this year has come from e-commerce.
Stores are still crucial to the growth strategy
The surge in e-commerce doesn’t replace new store openings. Lululemon plans on opening 30 to 35 net new stores this year. Lululemon’s stores are among the most productive in the retail industry, with high sales per square feet of $1,657 in fiscal 2019, and serve as important hubs for local events and online orders.
Stores are also important gateways to the brand for men, where Lululemon still expects to double men’s 2019 revenue level by 2023.
Why is the stock dropping?
The stock sold off following the earnings report, but investors can blame a rich valuation going into earnings for the drop. The company is performing well under the circumstances, but the stock had gotten ahead of actual business performance over the last few months. The stock was trading at a price-to-earnings (P/E) ratio of 87 going into the earnings report. It’s now at a P/E of 75, which is still high.
While the stock goes through a correction, Lululemon’s brand is very strong, as noted by people lining up to get in stores recently. Lululemon had approximately 97% of stores open, as of Sept. 8, and those stores are operating at about 75% of last year’s volume.
Once stores fully reopen and productivity is back to pre-COVID levels, the acceleration in the higher-margin e-commerce business will shine through in Lululemon’s earnings performance. This is a growth stock with high return potential over the long term, especially given the potential for international expansion, where Lululemon continues to invest.