Lululemon: Under Pressure, Overlooked Fundamentals, and Undervalued
The athletic apparel market, once a bastion of easy growth, has grown thorny. For LululemonLULU-- (LULU), the challenges are acute: tariffs, markdowns, and a softening U.S. consumer have squeezed margins and clouded near-term guidance. Yet beneath the noise, the company's fundamentals remain robust. International expansion is accelerating, and its balance sheet is strong. With a price-to-earnings (P/E) ratio of 11.28—well below its 10-year average of 41.92—investors may be overlooking a compelling opportunity in a stock that is arguably undervalued by 23% [1].
Revenue Resilience: International Growth vs. U.S. Headwinds
Lululemon's Q2 2025 results underscore a bifurcated performance. Total revenue rose 7% year-over-year to $3.6 billion, driven by a 25% surge in China and a 19% increase in the Rest of World segment [2]. These gains reflect the company's strategic pivot to international markets, where demand for premium activewear remains resilient. However, the U.S. market, which accounts for 60% of revenue, has faltered. Americas comparable sales dropped 2%, a symptom of reduced store traffic and weaker conversion rates [3].
The U.S. slowdown is not unique to Lululemon. The broader retail sector is grappling with inflation and shifting consumer priorities. Yet the company's international success suggests it can offset domestic weakness. China, in particular, is a bright spot. Lululemon's brand equity there, built on a blend of yoga culture and lifestyle marketing, has insulated it from some of the volatility affecting other Western brands [2].
Margin Pressures and Strategic Responses
The real test for Lululemon lies in its margins. Gross margin contracted 110 basis points in Q2, driven by higher tariffs, the removal of the de minimis exemption (which increased import duties), and aggressive markdowns to clear inventory [4]. Operating margin followed suit, compressing by 1.1% to 18.5% as selling, general, and administrative expenses surged 11.9% [3].
Management has acknowledged these pressures, projecting a full-year margin decline of 300 basis points—nearly triple prior guidance [4]. But the company is not passive. It is doubling down on product innovation, aiming to boost new styles from 23% to 35% of its offerings by Spring 2026. This shift targets the casual segment, a growth area that could diversify revenue streams beyond its core yoga and running categories [2]. Additionally, supply chain agility initiatives and cost-saving measures are expected to mitigate some of the margin drag [4].
Valuation: A Discount Amid Uncertainty
Lululemon's valuation metrics tell a story of dislocation. Its P/E ratio of 11.28 is 44% below the Consumer Cyclical sector average of 20.54 [5], while its EV/EBITDA of 7.34 suggests undervaluation relative to earnings power. Analysts have cut their 2026 earnings per share (EPS) forecasts, with William Blair lowering its target from $3.16 to $3.04 [4]. Yet these adjustments assume a worst-case scenario: that tariffs and markdowns will persist, and that U.S. demand will remain soft.
The reality may be more nuanced. Lululemon's liquidity is strong, and its balance sheet is a fortress. Even with 2025 revenue guidance cut to $10.85–$11.0 billion, the company is on track to exceed $11 billion—a figure that would have seemed optimistic just a year ago [4]. The “Power of Three x2” goal of $12.5 billion by 2026 may be out of reach, but the path to $11.1 billion (Jefferies' estimate) is still achievable with disciplined execution [2].
The Case for Caution and Opportunity
Baird's recent downgrade to “Neutral” highlights the risks: weak U.S. demand, margin visibility, and competitive pressures [4]. Yet downgrades often create buying opportunities. Lululemon's stock price, currently at $168.10, trades at a 23% discount to its calculated fair value of $225.76 [1]. This gap reflects pessimism about macroeconomic conditions but underestimates the company's ability to adapt.
For investors, the key question is whether Lululemon can restore margins without sacrificing growth. The answer hinges on its success in the U.S. and its ability to innovate. If the company can stabilize domestic sales and reduce markdown dependency, its valuation could rebound. The current P/E ratio, while low, may not fully capture the upside potential of a brand with a loyal customer base and a global footprint.
In the end, Lululemon is a stock of contrasts: under pressure from tariffs and a soft economy, yet overvalued by fundamentals that suggest resilience. For those willing to look beyond the near-term noise, it offers a compelling case of overlooked value.
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