Estimating 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$382

• With US$336 share price, Lululemon Athletica appears to be trading close to its estimated fair value

• The US$470 analyst price target for LULU is 23% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Lululemon Athletica Inc. (NASDAQ:LULU) by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

See our latest analysis for Lululemon Athletica

Is Lululemon Athletica Fairly Valued?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$1.28b	US$1.39b	US$1.56b	US$1.70b	US$2.01b	US$2.47b	US$2.75b	US$3.00b	US$3.20b	US$3.38b
Growth Rate Estimate Source	Analyst x12	Analyst x13	Analyst x13	Analyst x5	Analyst x2	Analyst x1	Est @ 11.65%	Est @ 8.84%	Est @ 6.88%	Est @ 5.50%
Present Value ($, Millions) Discounted @ 7.4%	US$1.2k	US$1.2k	US$1.3k	US$1.3k	US$1.4k	US$1.6k	US$1.7k	US$1.7k	US$1.7k	US$1.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$15b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.3%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$3.4b× (1 + 2.3%) ÷ (7.4%– 2.3%) = US$68b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$68b÷ ( 1 + 7.4%)¹⁰= US$34b

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$48b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$336, the company appears about fair value at a 12% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. 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 7.4%, which is based on a levered beta of 1.102. 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 revenue is forecast to grow faster than the American market.

• Current share price is below our estimate of fair value.

• Significant insider buying over the past 3 months.

Threat

• Annual earnings are forecast to grow slower than the American market.

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Lululemon Athletica, there are three relevant elements you should assess:

1. 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.

2. 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.

3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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.