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Lululemon Athletica Inc. has triumphed over economic uncertainty this year by smashing already lofty expectations.

What that means, however, is that the bar is now set even higher for the Vancouver-based seller of yoga gear and other athletic apparel. Shares in the company, which announces third-quarter earnings on Thursday, are priced for exceptional growth.



Anything less than another blow-out quarter is likely to disappoint investors who have become accustomed to seeing the company explode past analysts' forecasts.



Lululemon's recent $55 (U.S.) share price represents more than 47 times trailing twelve-month earnings and 42 times projected earnings over the next 12 months, according to Standard & Poor's Capital IQ. In comparison, sportswear competitors adidas AG and Nike Inc. carry multiples of 18 and 19, respectively, with only Under Armour Inc. similarly priced at a price-to-earnings ratio of 40.



"We see [Lululemon]as one of the most compelling concepts in retail but also believe there is a disproportionate amount of risk to earnings and sentiment at this company," said Jefferies and Co. Inc. analyst Taposh Bari, who cut Lululemon to "underperform" on Aug. 30.



He was too early with that call, if he was right at all. The stock had been trading in the $35 to $38 range in the days leading up to his downgrade, which came before the company's second-quarter earnings announcement.



In that announcement, Lululemon reported sales growth of more than 50 per cent, same-store sales gains of 31 per cent (adjusted for gains in the Canadian dollar) and a huge expansion in its profit margins. It then boosted its financial guidance for the remainder of the year. The stock blew past $40 that day and has now crossed the $55 mark in anticipation of more world-beating numbers.

Surprises



The soaring share price has surprised even some of the company's biggest advocates. Howard Tubin, a New York-based analyst for RBC Dominion Securities Inc., had a $48 target price on his last "outperform" note in late October. The analyst team at Robert W. Baird & Co. had a $51 target on their Sept. 13 "outperform" note.



The bulls see Lululemon as a well-positioned retailer in the early stages of a sustained period of rapid growth. The Baird analysts, for instance, believe that over the next three to five years, Lululemon has the potential to grow earnings per share by 27 per cent to 33 per cent a year thanks to more stores, double-digit sales growth at existing stores, and a slight improvement in profit margins.



The enthusiasts believe the yoga wear retailer has plenty of avenues for growth. For instance, the company started making significant online sales in 2009 and additional Internet retailing could provide a further boost to its top line.



So could further expansion in the United States. At the moment, Lululemon operates just 134 stores and "showrooms"- its low-cost trial locations - in 36 states. Given that Canada, with one tenth the population, supports 43 stores, there seems to be room for substantial U.S. growth.



In addition, the company, which previously targeted female shoppers, is expanding into men's active wear.



But doubts surround any company growing at such a rapid pace and Lululemon is no exception. One question is how long it can succeed in charging premium prices for its products. Mr. Bari, of Jefferies & Co., observed in a September note that a basket of six goods sold by Lululemon carried an average price of $67 - 40 per cent to 70 per cent higher than similar products from Adidas, Nike, Under Armour and Reebok International Ltd.



Skeptics point out that Lululemon's inventories have swelled, and were 44 per cent higher at the end of the last quarter than they were a year earlier. Growing inventories can suggest a retailer is having trouble moving products. Lululemon management, though, insists it's stocking up for a big sales season.



Mr. Bari believes Lululemon is ramping up inventory and spending on new stores at the wrong time, just as the U.S. retail environment is decelerating. He is in the minority, though. RBC's Mr. Tubin, who has an "outperform" rating on the stock, says he has "some comfort that [Lululemon]has not gone overboard on stocking up existing stores."



The biggest hazard in the near term is simply the enormous expectations that now surround the company. Lululemon is expected not just to beat the consensus forecast for earnings, but to thrash it. Rick Aristotle Munarriz, a contributor to The Motley Fool financial website, notes the company has surpassed analysts' profit targets by 25 per cent or better in each of the three past quarters.



If Lululemon merely slips past expectations Thursday, or, heaven forbid, misses them, no amount of deep breathing will calm the market's reaction.





Athletic Apparel: Price Comparisons, U.S. dollars

Brand

Yoga pants

Sports bra

Running shorts

T-shirt

Tank top

Track jacket

Average

Lululemon

$100

$45

$55

$55

$45

$100

$67

Nike

$40

$35

$30

$30

$35

$80

$42

Old Navy

$25

$15

$15

$10

$10

$20

$16

Source: Jefferies & Co. Inc. research



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