We are very happy to participate to the @commonstock July Idea Competition which is a real challenge given the current environment and the short time given to publish a qualitative write-up.

Our “best idea” is Lululemon $LULU which is consistent with our core Quality-Growth investment philosophy. We are looking to invest in companies with competitive advantage, structural growth perspective, led by the right management team with capital allocation skills and running a financially strong business.

Given the current volatile market fueled by inflation, recession fears and geopolitical tensions, we are more than ever interested in companies that set clear long-term goals and have an history of achieving those goals. It seems obvious, but few companies do it, and LULU

is one rare example. While many companies are reducing their growth targets in the face of a possible recession, LULU is pursuing its growth strategy with continued focus and defying the macro outlook.

Thesis:

One of the key factors that differentiates the company’s product design is its commitment to and investment in innovation, whether in new fabrics, categories, fits, or collaboration with the result that the company continuously releases new offerings that improve functionality or deliver new wearing options for consumer’s wardrobe. LULU’s keen focus on finding function in fabrics is a main element of its success that should continue to fuel sales gains as for-performance design and fabrics with sustained innovation can find buyers beyond the core yoga-wear community. The company’s product innovation is centered around meeting customer’s unmet needs by utilizing and creating new fabrics and close collaboration with vendors. LULU has shown the ability to build franchises that start as one product and it should be able to use this playbook for its core and new categories. The company continues to have a product innovation pipeline that focusses on the long-term as they identify long-term trends in consumer tastes, ESG, and new markets giving them an edge.

The four-year investment to develop new women’s footwear collection launched this year is the perfect example of this drive to innovate and it offers LULU potential to gain share in a fragmented market for women’s performance-sports footwear, given legacy athletic-shoe brands don’t have as big a headstart in making sneakers designed specifically for women.

LULU is debuting a footwear line that’s designed to meet women’s unmet needs first, leveraging the company’s history, research and category experience from its

apparel offerings.

For LULU the innovation pipeline is a cycle of continuous improvement over time. During the pandemic many retailers were forced to shift into defense mode at the expense of future innovation but LULU made the latter a priority to forge forward with product design, performance technologies and new category launches (tennis, golf, women’s footwear). This

focus on increasing share of wardrobe with flexible product for multiple wearing purposes (sport, lifestyle, OTC) continues to drive growth in the women’s business and give them the possibility to rapidly expend men’s and international’s current levels. The company is uniquely positioned with its core products now bolstered by its expansion categories.

Community is another company’s differentiating factor in the industry. In its early stage of growth, LULU’s primary source of advertising was community building. The company has chosen to do grassroots advertising, ambassadorships and guest relationships are the main vehicles for brand engagement and fostering loyalty. LULU’s entrenchment in communities

allows it to build deeper connections, while also providing access to new audience. The company has hosted thousands of global events, including flagships experiences such as Sweatlife festivals in Europe and 10K runs in America. Sponsoring Team Canada for last Beijing Olympics also boosted global awareness.

Looking ahead, the creation and launch of first ever membership program will create an ecosystem that increases the potential size of the customer base while at the same time strengthening its connections with guests. The program will be two-tiered:

Another key driver of LULU’s effort to increase its community and customer base is its seasonal store strategy as it creates unique guest experiences and provides an opportunity to test new markets post-pandemic before making longer-term commitment. 30% of all guests visiting seasonal stores are new, enabling faster customer acquisition in a lower-cost and flexible format.

LULU is evolving in a competitive industry with fierce competitors like Nike or Adidas, but we believe that thanks to its differentiating approach, LULU can grow and gain market share in the future. The conclude we highlighted below some extracts of an Adrienne Yih (Barclays Managing Director) interview about LULU’s pricing and brand power.

The company’s management outlined during the last investors day long-term financial targets of doubling total revenue to $12.5B (Power of Three x2) equating to a 15%+ revenue CAGR, with modest operating margin expansion annually translating into EPS growth exceeding operating income growth. Management sees the model growing at a 15% CAGR multi-year providing ample ability to chase upside and consistent with 19%/24% CAGR seen pre- and during pandemic. LULU has just 1% market share of the $650B global premium activewear market. The company shows investors in the past that it has the ability to meet guidance and even outpaced it with higher growth rates and targets reached years in advance.

Let’s now delve a bit deeper into the long term growth drivers:

Revenue topped $6.3B in 2022 (reporting on FY in Jan) representing an outstanding more than 20% CAGR since 2016. Gross margin grew even faster as the business grew and gained bargaining power with suppliers, gross profit margin improved from 48% to 58% in 2022.

Operating profit and Net Income grew in line with Gross Profit as operating expenses (as a % of revenue) remained stable. The company returned a constant long-term ROA around 20%. ROE improved significantly and can be easily explained by a combination of higher profits, introduction of debt in the balance sheet and shares count reduction.

From a liquidity point of view, the company’s balance sheet is pretty strong. However, it is important to notice that the liquidity level gradually declined over the period to 1.86 from 4.07 (current ratio). From our perspective, a current ratio above 1.5 is a satisfying liquidity level. The

lower liquidity can be explained by strategic acquisition but mainly by share repurchases program which benefits shareholders.

From a solvability point of view, LULU introduced debt into its balance sheet in 2020. Indebtedness levels remain reasonable and debt as source of capital, given the recent very low cost of debt, can be seen as a sensible decision. Solvability ratios improved years after years since 2020. To conclude, and if the above was not enough to reassure an investor, the company generated in 2022 an EBIT equivalent to more than 111K times the cash interest paid which provides further good signals regarding LULU solvability.

The company generated a FCF shy of $1B in 2022. Importantly, the latter grew 36% CAGR over the period and in line with Net Income. Main use of cash was the acquisition of fixed prod assets and shares repurchase.

The above table shows the unique profitability of the company within its group. The only ratio where LULU is close to the median is ROE, however it fails to account for LULU’s significantly lower debt levels than peers (i.e. 24.33% total debt/total assets vs. group median of 44.52%).

LULU has a good score using our Management Assessment Checklist, we particularly like management’s communication and capital allocation skills.

Through its mission statement, the company makes it clear that the popularity of its products does not precede the experiences that it desires its customers to enjoy. The use of strong terms in this statement is an indication of how passionate LULU is when it comes to initiating long-lasting behavioral changes in everyone it comes in contact with especially those that use its technical clothes for athletics. The mission statement comprises of these components: improving lives, improving health, exceeding expectations.

Management is smart in terms of asset allocation and methodical when executing long-term plan which clearly adds shareholders value. The company is the most profitable within its peer group with lower use of leverage. FCF yield is attractive and in addition, the company only used M&A at the margin, and has been mainly focused on reinvesting FCF into its fast and constantly growing business. The company does not pay dividends and given the positive spread between its ROIC and WACC, we believe it is the best decision.

Driving a sustainable pipeline of products through raw-materials innovation could help LULU entice customers that prefer brands that resonate more closely with their personal views for more sustainability especially among Millennials and Gen Z. PwC 2021 consumer survey revealed that the latter two groups are more likely to think about sustainability during shopping. The company is seeking to significantly change the way it sources and manufactures products across all its key raw materials.

LULU also announced the expansion of its first trade-in and resale program. The company leaps into the more than $30B resale market, estimated to surpass $75B in 2025 based on the Global Data estimates. Built on a circular economy model, it will allow the company to reach more value-focused shopper and sustainable-minded consumers. Customers can receive credits ranging from $5-25 for trade-in products that are being resold through the company’s own stores or website. This ESG friendly initiative aims also to increase store and online traffic, driving customer acquisition. LULU is leading versus peers and above median

regarding Environmental and Governance scores according to Bloomberg ESG metrics.

The company is currently trading well below its five year historical multiples. The current economic and geopolitical environment needs to be accounted to reflect inflationary environment and incremental freight and supply chain costs. However, we believe valuation also needs to recognize LULU pricing power, consistent sales trends, product innovation, category expansion, and historical experience of meeting targets. We computed a 12M price target of $380, representing a potential 36% upside.

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