Stock Analysis - lululemon athletica Inc. (LULU)
lululemon athletica (LULU) is an athletic apparel designer, distributor, and
retailer founded in 1998 in Vancouver by Chip Wilson. The company offers
products like pants, shorts, and tops which are designed for activities like yoga,
running, training as well as “other sweaty pursuits”. LULU is a premium clothing
brand with a strong reputation for product innovation; LULU primarily sells
women products (75% of net revenue) and sells them primarily in the US (305
out of 491 stores). LULU was better positioned as a digital retailer (54% of
revenue Q1 2020) to deal with Covid-19 compared to it's competitors and
capitalized further as athletic leisure wear became ideal for remote working.
LULU management projects mid-teens growth over the next 5 years and points
to Men's, digital, and Chinese markets as key growth areas. This clearly has
been priced in already as LULU increased 40% in value since the start of the
year. A SELL rating is assigned because LULU's edge in the current crisis is
overstated and management's projections of growth are too optimistic.
Above: Selection of useful data
lululemon's edge is overstated
LULU's strong digital presence was not enough to offset the losses in store closure as shown in its Q1 earnings call. In this quarter e-commerce sales totaled $352 million compared to the $1.1 billion in 2019 showing that LULU wasn't very effective in transferring its retail sales to digital sales. Short term sales won't increase because digital demand is not growing, it is only pushed forward.
■ If a vaccine isn't developed in the near future (there should be no expectation
as similar corona-viruses like SARS and MERS are still untreated) LULU will
have to operate in the "new norm". Activities like shopping and yoga classes
will be considered high-risk and will certainly not function at maximum capacity
due to social distancing measures. As more people exercise at home LULU
will struggle to increase its brand exposure and generate new customers.
LULU relies heavily on word of mouth as its apparel has minimal branding and
consistently prices its products above competitors and will suffer more as a
result. It is unlikely that consumers will be purchasing premium yoga wear as
brand value loses its appeal when exercising in isolation. Consumers will also
have less cash to spend as unemployment is projected to be 6~10% through
to 2023. Data is provided as a pricing comparison between different brands.
■ If a vaccine is developed there is no reason for LULU to trade higher than its
pre-Covid price ($231). Bigger companies like Nike and Adidas are better
equipped for this crisis and have established their brand and presence.
lululemon's growth projection is not reasonable
Management predicts double-digit EPS and mid-teens sales growth through to 2023; they
expect men's and digital sales to double and plan to expand aggressively in China. In Q1
2020, LULU has already fell short by $198 million in its effort to double digital sales (only
64% increase) despite the tailwind provided by the closure of all retail stores. Digging
deeper shows that LULU would also struggle to reach its ambitions with Men and Chinese.
■ China will not warm to LULU
When deciding on a name for his company, Chip Wilson purposefully used the
alliteration of the letter “l,” knowing that Japanese knock-off distributors would have
difficulty pronouncing it. China is now the world's biggest counterfeit market with an
advanced capability of reproducing luxury designer brands. China is LULU's biggest
supplier (more than the Americas combined) and is well known for its reduced
protection of intellectual property rights and trademark. As of 2018, the average salary
of a fitness center member in China made less than 1000 dollars a month; cheaper
alternatives from better known brands (Uniqlo, Nike, etc) and other unbranded
sportswear (~$20) are much more attractive. Foreign brands have always had a
difficult time establishing their presence in China, Starbucks for example took on 9
years of losses before becoming profitable. Partnering up with gyms, marketing, and
growing store numbers all require high amounts of investment that will decrease
margins. The US-China trade war also has significant potential to harm the business;
tariffs and regulations aside there is a growing sentiment that Chinese people should
support Chinese companies by buying from them.
■ No evidence of present or potential future men's growth
Over the last two years, revenue growth for men's products have been 4.3% and 5.8%
respectively. LULU is not on track to achieve 100% growth target and it's easy to
understand why. Despite selling "performance wear", LULU will find it hard to acquire
performance wear seeking consumers because of its existing reputation as a yoga/
lifestyle brand. Nike/Adidas/UA are more dominant in this area as their brand value has
very strong ties to team sports. Nike has spent more on sponsorship deals with Lebron
James, Cristiano Ronaldo, and Neymar than lululemon has on their entire history of
marketing campaigns. There is also little evidence that lululemon's athleisure fashion
values have captured the attention of male consumers.
Risk to thesis & closing remarks
There are a lot of risks to this investment thesis. In general, the sports equipment and
sportswear industry is growing rapidly in China. As the quality of life increases, there will
be a growing demand for brands like LULU. Most notably LULU has done well (relative to
competitors) to avoid trade tariffs and has also tailored its products to fit the Asian body
typer which has been received well by consumers. LULU is also successfully maintaining
its community through free online yoga classes/webinars which have been extremely
popular. In the new norm consumers are likely to spend less on outdoor activities like pubs
and clubs and might use the excess money to invest in personal equipment and clothing.
Furthermore, investing in equities might be a hedge against potential inflation.
Based on all the above, it is more likely that LULU grows sales at high single digits (5-7%)
rather than the mid-teens management expects. EPS growth is also more likely to be at
6-8% rather than the double digits the street forecasts.
Comparable Company Analysis
CCA was performed to estimate LULU's implied value; this a relative valuation method based on the market's views of this particular industry. Adidas, Nike, and Under Armour were chosen as the comparable companies for their similarity in geography, industry, and size. The multiples used were EV/REVENUE and EV/EBITDA. Values for EV, Revenue, and EBITDA were taken from the years: 2019 (A), 2020 (E), and 2021 (E) via CapitalIQ. Historical results gave grounding while projected results gave an insight to the future expectation of the companies. The minimum, 25th percentile, median, 75th percentile, and maximum values for the metric were calculated. Plotting a football field chart showing the 25th percentile to 75th percentile suggests that LULU is overvalued. It is worth noting that UA, Nike, and Adidas are bigger companies with a smaller room for growth when compared to LULU. CCA doesn't correctly price LULU's growth potential so the target price will be considered using higher percentiles.
By Mac Zhou, Oxford University
Below are references and CCA excel modeling information:
China Thesis: PWC Digital IQ Score
consumer breakdown statistica: