Lululemon reports results for the second quarter of tomorrow: will it maintain success while battling supply chain costs?

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Lululemon Athletica‘s (NASDAQ: LULU) first-quarter sales rebounded from last year’s pandemic-induced drop. However, the recovery was not easy. The sportswear maker faces a new set of challenges regarding its supply chain and material shortages, and investors will be eager to understand its impact when the company releases its results tomorrow.

With economies reopening and more and more people visiting stores in person, customer interest is obviously increasing compared to last year. Additionally, the warmer weather means people engage in outdoor fitness activities more frequently, meaning the company’s second-quarter sales are also expected to be driven by a seasonal tailwind. The difficulty, however, is meeting this customer demand in a cost-effective manner.

Lululemon is trading at a futures price-to-earnings ratio of 58. Image source: Getty Images

Strong sales, but keep an eye on costs

Investors will pay close attention to management’s comments on the company’s supply chain. Several companies are reporting problems with shortages of materials and rising costs of shipping products. Inventory levels for the second quarter should give some indication of whether this is an issue at Lululemon. At the end of the last quarter, the company reported $ 733 million in inventory on hand, a 17% increase from levels a year ago, which should allay immediate concerns.

The good news about supply shortages in the industry is that fewer companies are offering discounts and promotions, which means more products are sold at or near full price. It remains to be seen whether higher margins on goods will be enough to offset rising costs for materials and freight.

And as supply chain shortages persist across all industries, shareholders will want to watch the company’s inventory levels as the second quarter ends. If the company has strong sales but fails to replenish inventory, it could hurt sales for the next quarter or two.

Revenue increased 88% in its last quarter. Of course, that was compared to the lower numbers from the same period last year, when many of its stores were still closed. Yet looking back two years, the sales of the stores operated by the company were 3% higher. Meanwhile, e-commerce revenue grew 55% from last year.

Digital sales remain the key

Lululemon has a strong digital channel where e-commerce sales totaled 44% of revenue in the last quarter. This is relevant because digital sales are direct to customer sales that eliminate another retailer in between and thus increase profit margins. In contrast, rival Nike (NYSE: NKE) often sells its products through retailers like Nordstrom and Macy’s. Nike has to sell its products to the aforementioned chains at lower prices so that they can also make a profit, which is eating away at Nike’s margins.

Indeed, Lululemon has averaged an operating profit margin of 21.2% over the past decade, while Nike has averaged 13.2%. And at the same time, Lululemon is increasing its revenue to more than double the rate of Nike. The higher profit margin can in part be attributed to its robust digital channel, while the higher growth is in part due to departing from a smaller revenue base.

What this could mean for investors

Wall Street analysts expect Lululemon to report revenue of $ 1.33 billion and earnings per share of $ 1.18 in the second quarter. If the company reports estimated EPS growth, it would be a 59% increase from the previous year.

A graph comparing the price / earnings ratios of Nike and Lululemon.

Data source: YCharts.

With the worst of the pandemic behind him, Lululemon appears to be in a great position. It is trading at a futures P / E of 58, compared to Nike’s 38 (see chart). However, the premium could be justified given that Lululemon operates with much better profit margins and grows revenue faster than Nike. Long-term investors may feel good about adding the stock to their portfolio.

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Parkev Tatevosian owns shares in Macy’s. The Motley Fool owns shares and recommends Lululemon Athletica and Nike. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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