• Brett Schafer

Not So Deep Dive: Lululemon Stock



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Show Notes


(Ryan) What they do: Most people know what they do, but I’ll give a brief description anyways. Lululemon is a designer, distributor, and retailer of apparel and accessories. They have a range of products spanning the men’s and women’s categories (women accounted for 67% of sales in 2021) from athletic clothes to casual, and one common trait among many of their clothes is the simplicity of design. The logo is not very prevalent.


Life of a product: For the development stage, Lululemon employs a number of researchers, scientists, engineers, and designers who all help come up with product designs. From there, Lulu partners with several inspections, verification, and testing companies who test various performance characteristics for all their products. Once a product is ready to be developed, Lulu has 65 different fabric suppliers that it procures from and 41 vendors that manufacture for them. Just under 70% of their manufacturers are based in Vietnam, Cambodia, and Sri Lanka (with the majority being in Vietnam). Once a product is made, it is shipped to one of Lululemon’s various distribution facilities located in either Australia, the US, or Canada (only one of these is owned, the remainder are leased). Once they’ve made it to the DCs they are then sent to either one of Lululemon’s 579 retail stores (67% of which are in North America) or customers' homes for e-commerce orders.


Obviously, there’s a lot of shipping involved in that process and the supply chain is a hot topic, so I found this stat helpful. From 2019 to 2021, costs incurred to transport products from Lululemon’s distribution facilities to its retail locations and e-commerce guests increased by 154%.


(Ryan) History: Lululemon was originally founded by this sort of interesting character named Chip Wilson in 1998 in Vancouver, CA. Chip Wilson received a bachelor's degree in economics from Calgary and seemed to have had an interest in retail for a long time. In 1979, he started a retail store called Westbeach Snowboard, which sold clothes for surfers, skaters, and snowboarders. But in 1998, he sold the company and started Lululemon. Originally, the Vancouver location was a design studio during the day and a yoga studio at night, but after some success with their apparel, they quickly established a standalone retail location.


Simply put, they had a product-market fit. And they took off, adding lots of stores. In 2007, they went public, and in 2008 a new CEO was hired. There have been some interesting quotes from the founder though over the years, which I think are worth noting.


  • He named the company Lululemon because Japanese people couldn’t pronounce the letter “L”. He said later on "It's funny to watch them try and say it,"

  • He also had this weird blog post in 2009 where he attributed Lululemon’s success to the rise in birth control. In the article, he says this gave rise to the “Power Woman” and he wrapped it up by saying “Ultimately, Lululemon was formed because female education levels, breast cancer, yoga/athletics, and the desire to dress feminine came together all at one time”

  • He’s no longer on the board.


(Brett) Industry/Landscape/Competition:

  • The athleisure industry is maybe surprisingly large. $411 billion in 2021 is projected to hit $793 billion in 2028. Pretty simple to understand the tailwind of more casual clothing items globally that has been going on for decades

  • Competitors: Nike, Adidas, and then just tons of smaller brands that you might group as the “Instagram-based competitors.” Essentially, anyone that is looking to steal wallet share among athleisure shoppers


(Brad) Management

  • CEO is Calvin McDonald

  • Disney BOD

  • Former Sephora President

  • Former President and CEO of Sears Canada

  • 85% rating with 5000+ reviews on GlassDoor

  • CFO Meghan Frank

  • Former VP at Ross and J Crew

  • Director at Saks Fifth Avenue

  • CTO (interesting) Julie Averill

  • CIO at REO

  • VP at Nordstrom

  • Professor at Seattle University


Ownership:

  • McDonald owns a small portion of the float outright along with the rest of the team but there are special founder shares in there to add to their voting power which adds to voting power from execs by about 4%.

  • Few funds with hefty stakes – FMR LLC 14.4%; Vanguard 7%; T Rowe Price 6% BlackRock 6% Prudential 5.7%


(Brett) Valuation:

  • Market cap $34.6 billion, ticker LULU

  • P/S of 5.2

  • P/GP of 9.2

  • P/OI of 24

  • Share count has started to come down due to the buyback program. Something to watch is if price gets more reasonable how much they can reduce share count each year


(Ryan) Earnings:

  • Really solid 1st quarter from the company. Especially compared to other retailers.

  • Net revenue was $1.6B for the quarter, up 32% YoY (for reference, they’ve done just under $7B over the LTM)

  • Total comp sales increased 28%

  • 24% comp store sales + 32% increase in DTC net revenue

  • The gross margin was 53.9%, which was down slightly from last year

  • But their operating margin actually increased to 16.1% (saw rising costs from freight but were able to decrease SG&A expenses as a % of revenue)

  • 20% of their Chinese stores were closed during the 1st quarter. (15% of their stores are in China)

  • Opened 5 new stores during the Q. Total store count up 11% YoY.

  • They did not see the impact of stimmies last year so comps weren’t as difficult as some other retailers.

  • Also bought back $233M worth of stock during the Q. Reduced the share count QoQ by 0.25%.


(Brad) Balance sheet and liquidity:

  • $650 million in cash vs. $1.26 YoY

  • Added about $300 million in inventory

  • Very profitable

  • $400 million 5-year credit revolver – $396.9 million in remaining capacity with very favorable rates all under 2%

  • Has another $20 million China Mainland revolving facility which was raised to $35 million in 2020.

  • Issued and outstanding share count is very similar so no heavy dilution there but 400,000,000 shares are authorized with 122,000,000 issued so they have broad flexibility to do an equity raise here or pay employees with stock if they want


Anecdotal Evidence:

  • (Ryan) Same as Brad. I wear a lot of lululemon clothes. They look good and feel good. I really like the pants, and frankly, it’s a bit of social signaling.

  • (Brett) Everyone loves them but I can’t figure out why.

  • (Brad) I love the clothing. Half of my wardrobe. Work out, go out… anything. Expensive but lasts such a long time.


Future growth opportunities:

  • (Ryan) I don’t want to see them make any more acquisitions. My future growth opportunity is what they’ve been doing. Add new stores, expand product offer, increase prices, and buy back shares when it makes sense.

  • (Brett) Shoes. It would be tough to dethrone Nike/Adidas, but the launch of the new shoe line seemed to go well. This is a gigantic category and could be the next big thing to keep revenue growing 15% - 20% this decade.

  • (Brad) International Expansion. It’s still early innings here and I think it makes a lot of sense to see this brand find global success, especially in Western Europe where tastes are similar.

Highlights and lowlights:

  • (Ryan) Highlights: Remarkable brand. Resilient consumer demographic. History of successful product expansion. Pricing power. Lowlights: Mirror acquisition seems to have been really dumb. I just struggle with retail.

  • (Brett) Highlights: High margin category, elevated itself out of the middling DTC brands, the omnichannel strategy gives them an advantage in catering to core customer and potential with expansion into shoes. Lowlights: High employee count (29k) gives them a major risk to wage inflation, products made in Asia mean there are cost risks with transport, energy, etc, classic inventory management worries with a retailer. I don’t truly understand what they are selling. Mirror.

  • (Brad) I think this is a generational brand like Nike and Adidas and will blossom into the clear number 3 in active wear behind those two. Macro – there are countless knock-offs to the LuLu brand and with inflation raging, fringe consumers in LuLu’s demographic could seek out more affordable options like gym shark.


Bull Case:

  • (Ryan) 10%+ comp sales, 5% store count growth, and steady operating margins over the next 5 years. Gets them to just under $14B in revenue and ~$3B in operating income. Assuming 20x OI, you’ve got a $60B market cap company (plus whatever cash they generate in the meantime). That’s about a double vs. today with what seem to be very plausible estimates.

  • (Brett) If they get close to the growth target by 2026, maintain close to current profit margins, and the stock keeps a 20x+ earnings multiple, the stock will do fine.

  • (Brad) I think this can be compounded above 15% for a very long time and we don’t really need a lot of margin expansion to make that work. I think we’re a few quarters away from the multiple looking really good and being able to capture that 15% compounding in terms of returns. I will probably own this, this year.


Bear Case:

  • (Ryan) Cost increases persist and they can’t overcome them. Let’s say operating margins fluctuate between 10%-15%, instead of the 20% they’re at over the last twelve months, you could get a market underperformer here. Also, the China store shutdown gets worse and not better.

  • (Brett) Margin compression due to macroeconomic factors + last three years was a one-time growth bump that will turn into a headwind. If top-line growth isn’t double-digits, hard to see the stock doing well over the next five years.

  • (Brad) I don’t like relying on brand strength. See LA Gear etc.



Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.

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