Morgan Stanley Upgrades Lululemon, Says It Can Return To Age Of Outperformance

• Lululemon Athletica inc. LULU shares have lost 5 percent year-to-date, and are down 20 percent since June 22, 2015.
• Morgan Stanley’s Kimberly C. Greenberger upgraded the rating on the company from Equal-weight to Overweight, while raising the price target from $56 to $68.
• Greenberger believes that the company could achieve an EPS inflection in 2016, driven by sales growth and margin improvement.

Analyst Kimberly Greenberger mentioned that Lululemon Athletica has the potential to achieve an EBIT inflection in 2016, backed by a return to 20 percent EPS growth.

The company’s shares have lost 5 percent year-to-date and are down 30 percent over the past 3 years. Hence, Lululemon Athletica reporting double-digit EPS growth in 2016 could result in the shares outperforming again, Greenberger wrote.

For the past 2.5 years, the company has struggled with inconsistent execution, earnings volatility and management turnover. Lululemon Athletica has slowly recovered from these challenges and its new leadership has exhibited the ability to reaccelerate sales growth.

In the report Morgan Stanley noted, “2Q's +11% comp on the heels of 1Q’s +6% and 4Q’s +8% suggests consumers are returning to the brand -- our greatest source of skepticism following 2013's product recall, and a key tenant of our prior EW rating.”

Greenberger added, however, that despite an improvement in sales growth, Lululemon Athletica’s margins continue to contract and the company is unable to report earnings growth. The company is now poised for an EBIT margin inflection in 2016, which is predicated on “a modest but achievable” gross margin expansion of +100 bps, combines with +MSD comps.

“We see a compelling entry point and attractive risk/reward, but acknowledge our call could prove early given still elevated inventory levels (total +59% 2Q15),” the report stated.

The EPS estimates for 2015 and 2016 and 2016 have been reduced from $2.02 to $1.98 and from $2.41 to $2.40, respectively. The EPS estimate for 2017 has been raised from $2.76 to $2.86.

Earlier this month, Oppenheimer’s Anna Andreeva maintained an Outperform rating on Lululemon Athletica, saying that the company’s gross margin miss in 2Q appeared transient.