TLDR;
This episode analyzes Lululemon, a company with strong brand recognition and impressive financial metrics, but whose stock has recently declined. It explores the reasons behind Lululemon's success, its potential challenges, and whether its current valuation presents an attractive investment opportunity.
- Lululemon has experienced significant revenue growth and boasts industry-leading margins and returns on capital.
- The company's direct-to-consumer (DTC) model gives it greater control over its brand and customer experience.
- Expansion into China and menswear represents significant growth opportunities.
- Challenges include increasing competition, potential shifts in consumer preferences, and the need to maintain its premium brand status.
Intro [0:00]
The hosts introduce Lululemon, highlighting its impressive sales growth, strong brand, and high margins. Despite these strengths, the stock's price-to-earnings (PE) ratio has fallen dramatically, suggesting the market has soured on the company. The discussion aims to explore whether this negative sentiment is warranted or if it presents a buying opportunity.
Why Lululemon has such a cult-like following. [3:53]
Lululemon was founded in Vancouver in 1998 and opened its first US store in 2003. The company gained popularity by creating flat seams on yoga pants, which reduced discomfort, and using high-quality, comfortable fabrics. This innovation helped revolutionize the athleisure market, shifting the mindset from wearing old clothes to the gym to making a fashion and identity statement through workout attire.
What makes Lululemon products so special. [6:49]
Lululemon's high margins are attributed to its pricing power and operating leverage. In 2024, the company reported its highest operating margins in a decade, although tariffs are expected to impact this. Lululemon's gross margins have averaged around 58%, significantly higher than its peers. The company's ambitious five-year plan, announced in 2022, aimed to double revenue by 2026, driven by growth in menswear and international sales. While they may fall slightly short of this goal, their revenue has nearly doubled.
How new competitors are challenging Lululemon on the margins. [13:51]
Retail is a tough business, with many brands rising to prominence only to fade away. Nike has maintained its position due to its presence in nearly all global sports. Lululemon faces increasing competition as the sportswear category grows, and it must continue to innovate with new fabrics and technology to retain its market share.
How the future of Lululemon may be defined by China and menswear. [23:46]
Lululemon's overseas opportunities, particularly in China, are crucial for its future growth. China is Lululemon's second-largest market, and the company is significantly increasing its store count there. Unlike in some other markets, Lululemon does not lower prices in China, making it a premium brand. The bare case for Lululemon centers on strong competition in its key apparel categories. A misstep or scandal could quickly erode market share.
Why the setup for LULU stock may be even more attractive than Nike. [29:33]
Lululemon generates less than 10% of its sales through third-party retailers, primarily selling through company-owned stores and e-commerce. This direct-to-consumer (DTC) model gives them more control over pricing, product assortment, and customer experience. Competitors selling wholesale lack this control and must share margins with retailers. Lululemon's brand power allows it to draw customers specifically to its stores.
What to know about possible yellow flags with the business, like its declining inventory turnover ratio and expanding cash conversion cycle. [56:35]
Lululemon's cash-to-sales ratio has declined significantly, from 37% in 2017 to around 12% today. This could indicate unsustainable growth or increased investments and share repurchases. The company's cash conversion cycle has also increased, meaning it takes longer to convert inventory into cash. This could be due to stocking up too quickly or expanding product offerings.
Why the company’s acquisition of the sports-tech hardware company, Mirror, failed so miserably. [1:04:44]
Lululemon's acquisition of Mirror, a sports-tech hardware company, for $450 million proved to be a mistake. The concept of socially connected fitness gained traction during the pandemic, but the demand for Mirror's smart TV mirrors waned in a post-pandemic world. Lululemon has since rebranded the offerings as Lululemon Studio, focusing on app-based workout content and partnering with Peloton.
How to think about modeling LULU’s intrinsic value. [1:10:03]
To estimate Lululemon's intrinsic value, the North American business is separated from China and the rest of the globe to see the growth rates. A base case assumes 4% annual sales growth in the Americas and 18% internationally. Operating margins are projected to average 21.8% over the next five years, accounting for potential tariff impacts. A fair exit multiple of 20 times earnings is used, resulting in a present fair value of around $300 per share and a target buy price of $240 per share.
Whether Shawn and Daniel add LULU to their Intrinsic Value Portfolio. [1:19:04]
A bear case scenario considers the impact of Lululemon losing market share and pricing power, drawing on case studies of other brands like Under Armour and Victoria's Secret. A floor price of $159 per share is set, representing the stock's value if margins decline and sales in North America stagnate. A bull case scenario envisions continued growth in North America and strong international expansion, with gross margins remaining high and operating margins resilient. This results in a fair value of around $390 per share. Lululemon is added to the portfolio with a 5% weighting.