Lululemon Athletica Earnings Preview: 3 Key Items to Watch

lululemon athletica (NASDAQ: LULU) will report its second-quarter earnings on Thursday, Aug. 30, after market close. Since the second quarter of last year, Lululemon has put on a show for investors, blowing past expectations, and sending the stock up 137% over the past year.

Heading into the second-quarter earnings report, there's not much room for error, with the stock trading at a relatively high earnings multiple of 42 times forward earnings estimates. I'll review three key areas -- international sales growth, online growth, and margin performance -- in which Lululemon needs to perform well to meet high expectations.

Big international opportunity

In the last quarter, Lululemon continued to post robust comparable-store sales growth internationally, with 50% comps growth in Asia and double-digit growth in Europe. The company still has a small footprint overseas, with only 13 stores open in Europe and 23 stores in Asia. That compares to 404 total stores open worldwide.

Where Lululemon is opening new stores illustrates where management sees the biggest opportunity. In 2018, the company plans to open a total of 40 to 50 company-operated stores; however, at least half of those (20 to 30) are planned for international markets. And most of the international store openings (15 to 20) are expected to be opened in Asia.

This will almost double the number of stores in Asia. Plus, management is increasing the square footage of its new international stores, reflecting management's view that Lululemon's "stores remain among the most productive in apparel retail." Indeed, Lululemon stores generated $1,554 in sales per square foot in fiscal 2017, which puts the yoga brand toward the top of the retail industry on that measure of store productivity.

It's clear that Asians love the brand, and management sees a big opportunity to allocate capital in a booming international market, where it can generate high returns from high store productivity on behalf of shareholders.

Online sales growth

Along with international sales growth, investors will want to watch the growth rate in direct-to-consumer (DTC) revenue, which reflects how well Lululemon's online strategy is working.

On the digital side, the company saw tremendous improvement in 2017. After starting last year with flat DTC growth, the company introduced changes to its website that allowed the company to finish the year with a 27% increase in DTC revenue over fiscal 2016.

In the first quarter of this year, DTC growth accelerated to 62% year over year, reflecting a culmination of "structural long-term investments" that management has made, to drive both guest acquisition and conversion across both stores and e-commerce. Lululemon saw an increase of 28% in guest acquisition and a 20% increase in conversion last quarter, which was credited to improvements in the website and mobile capabilities.

Lululemon may just be getting started with its growth online. Chief operating officer Stuart Haselden said that "as we are finding success in driving higher traffic levels, we're also delivering a better online experience for our guests." The company continues to make adjustments to the website in order to improve traffic and conversion, with "better landing pages, enhanced content, and improved navigation and merchandising."

Margin expansion

Lululemon's digital strategy is clearly helping the company reach more consumers, but it's also having positive results for the company's margins.

The blistering pace of DTC sales growth is causing the category to become a larger contributor to the company's top line. DTC made up 24.3% of total revenue in the first quarter, up from 18.7% a year ago. As that trend continues, Lululemon has a big margin-expansion opportunity, since DTC sales generate almost twice the operating margin that company-operated stores do.

A combination of a 370-basis-point improvement in gross margin, resulting from operational efficiencies and lower markdowns, and a larger contribution from DTC caused adjusted operating income to climb 65% in the last quarter. That carried down to a 71% increase in adjusted earnings per share.

The margin expansion's impact on the bottom line has no doubt played a large role in sending shares soaring lately, so investors will want to keep a close eye on margin trends.

Lululemon has more room for improvement

With 25% year-over-year growth in total revenue last quarter and adjusted earnings growth of 71%, you might think that Lululemon couldn't perform any better. But it was encouraging to hear during last quarter's conference call that management is not resting on its laurels.

Executive chairman Glenn Murphy said "nobody's doing a victory lap" at headquarters. He added, "there's a senior management team who are heading down, executing on the 2018 strategic initiatives to take our business to a whole other level."

The consensus analyst estimate for the second quarter is anticipating year-over-year adjusted EPS growth of 26%, to $0.49, and revenue growth of 15%, to $667 million. If the company beats those numbers, the stock may not be done hitting new highs.

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John Ballard has no position in any of the stocks mentioned. The Motley Fool recommends Lululemon Athletica. The Motley Fool has a disclosure policy.