Here's Why Morgan Stanley Likes Lululemon's Report

Lululemon Athletica inc. LULU reported its 1Q comp and gross margin ahead of expectations, while guiding to gross margin inflection in 2Q and 2016. This led to the stock appreciating 5 percent.

Morgan Stanley’s Kimberly C. Greenberger maintains an Overweight rating on the company, while raising the price target from $71 to $74.

EPS Upside

Although the company reiterated its 2016 EPS guidance, Greenberger believes the guidance appears conservative and sets the stage for positive EPS revisions.

Despite the strengthening of the Canadian dollar, which came at a cost of 10 percent to the EPS, Lululemon was able to hit the high end of its EPS guidance for 1Q.

“On top of 120 bps 1Q GM upside, management reassured investors that with 6 weeks of 2Q sales visibility, it remains confident it can deliver a 2Q GM inflection. This marks a critical turning point in the LULU story,” Greenberger stated.

Related Link: Lululemon Volatile After Q1 Report, Hasn't Closed Above $70 Since 2013

Gross Margin Inflection

Given the magnitude of the comp and gross margin beat in 1Q, the analyst believes that the guidance sets 2016 up for a “beat and raise story.”

After a 130 bps gross margin upside in 1Q, management guided to a 120 bps year-on-year improvement in the 2Q gross margin, ahead of the consensus and the estimate.

The inventory to sales spread narrowed in 1Q, alleviating concerns regarding an overhang of Lululemon’s 2015 inventory on 2016.

The company reported sector-leading top line growth. “This outperformance came against a challenging retail backdrop and data that suggest the 1Q wholesale athletic apparel market slowed, particularly in women's,” Greenberger pointed out.