lululemon athletica's Brand Continues to Sizzle

lululemon athletica (NASDAQ: LULU) has successfully completed its comeback over the past year, but that has left the company with sky-high expectations to meet to justify a pricey valuation placed on the stock. The yoga retailer continued its impressive string of growth in the third quarter by reporting blistering growth rates for revenue and adjusted (non-GAAP) earnings per share of 21% and 34%, respectively, over the year-ago period.

The shares sold off the day after the report, as the company's outlook was already what investors were expecting. But make no mistake, Lululemon's business momentum is real and there's no sign of it slowing down. Let's take a look at some of the highlights of the quarter that show just how well the company performed, along with what management had to say about the results.

Must-have product

Once again, the highlight for Lululemon continues to be the amazing growth in its online business, which grew 46% year over year on a constant currency basis, while China e-commerce revenue surged 71% year over year. Store traffic was up in the high single digits, while online traffic jumped more than 35%. For the quarter, e-commerce revenue made up 25% of total revenue.

One of the primary reasons for the acceleration in online growth this year has been enhanced digital marketing strategies that management put into place heading into 2018. The customer email file increased 90% year over year, which has helped Lululemon stay connected with customers.

But most importantly, Lululemon's product team has been on the ball lately. The brand has successfully expanded from core workout items like running shorts and yoga pants to everyday wear, which has been met with an overwhelmingly positive customer response. The company cited particular strength in new outerwear items, such as the new Cloudscape Jacket for women and the Outpour Parka for men. Men's and women's comps grew 150% and 40%, respectively, in the outerwear category.

Management sees a big opportunity to expand further into everyday wear. During the call, Chief Product Officer Sun Choe said, "They definitely represent a significant amount of opportunity and given our position of the intersection of feel, fashion, and function, we feel like there's a white space beyond the categories that we're known for today."

Pricing power

Management is seeing the strong momentum continue into the fourth quarter. Lululemon is in the great position right now of being able to fuel further innovation with its recent financial success.

One of the things management is currently investing in that sounds really promising is a new loyalty program. In select markets, the company is offering a range of benefits for a fixed annual fee. For $128, customers can choose a free pair of pants or shorts, curated Sweat Classes, free fast shipping with online orders, and early access to Sweatlife Festivals and other events the company hosts throughout the year.

Based on the engagement and response management has seen from customers so far, they think there is an opportunity to increase the fee. This is true for the product, as well.

Some of the outerwear items Lululemon released recently are priced from around $200 to as high as $598. Choe said, "So far we really have not seen price resistance where we've introduced [extra features] and priced it at a premium. So we believe that continuing to innovate on solutions for our guest, and if there is value there, we can continue to push prices up."

I can't emphasize enough how great it is for a company in the highly competitive retail industry to be in the position of raising prices for loyalty programs and products that are already perceived as pricey to begin with. This means the margin expansion story may be far from over, which bodes well for future earnings growth.

Sizzling 2019?

Lululemon may have the most powerful and influential brand in the apparel market right now. But given how strong 2018 has been for Lululemon, the year-over-year comparisons will get tougher in 2019, which means growth rates in the coming quarters may be lower. But management has repeated throughout the year that they continue to see areas to improve margins by lowering product costs. That should keep earnings growing faster than revenue.

Analysts currently estimate the company will grow revenue 14% next year, which is expected to translate into 18% growth in earnings. Expectations are still at a sky-high level for the long term, but management thinks they have built a solid foundation for the future. Haselden said, "I believe we will look back on 2018 as a milestone year for Lululemon, where the culmination of our multiyear investments in supply chain, technology, and innovation broadly have delivered an inflection in our business that has set us on a new trajectory."

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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.