Calculating The Intrinsic Value Of Lululemon Athletica Inc. (NASDAQ:LULU)
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Lululemon Athletica fair value estimate is US$315
Current share price of US$263 suggests Lululemon Athletica is potentially trading close to its fair value
Analyst price target for LULU is US$316 which is similar to our fair value estimate
Does the September share price for Lululemon Athletica Inc. (NASDAQ:LULU) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
View our latest analysis for Lululemon Athletica
Step By Step Through The Calculation
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF ($, Millions) | US$1.37b | US$1.53b | US$1.50b | US$1.92b | US$1.98b | US$2.03b | US$2.09b | US$2.14b | US$2.20b | US$2.25b |
Growth Rate Estimate Source | Analyst x8 | Analyst x9 | Analyst x5 | Analyst x2 | Analyst x1 | Est @ 2.68% | Est @ 2.62% | Est @ 2.59% | Est @ 2.56% | Est @ 2.54% |
Present Value ($, Millions) Discounted @ 7.0% | US$1.3k | US$1.3k | US$1.2k | US$1.5k | US$1.4k | US$1.4k | US$1.3k | US$1.2k | US$1.2k | US$1.1k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$13b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$2.3b× (1 + 2.5%) ÷ (7.0%– 2.5%) = US$51b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$51b÷ ( 1 + 7.0%)10= US$26b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$39b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$263, the company appears about fair value at a 17% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Important Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Lululemon Athletica as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 7.0%, which is based on a levered beta of 1.101. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
SWOT Analysis for Lululemon Athletica
Strength
Earnings growth over the past year exceeded the industry.
Currently debt free.
Weakness
No major weaknesses identified for LULU.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Good value based on P/E ratio and estimated fair value.
Significant insider buying over the past 3 months.
Threat
Annual earnings are forecast to grow slower than the American market.
Moving On:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Lululemon Athletica, we've compiled three relevant items you should look at:
Financial Health: Does LULU have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does LULU's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.