lululemon athletica inc.

This is section one of Tomorrow's News of the Week Post. Thought I'd give Commonstock a lil sneak peak! I'll link the trade when it gets entered.
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This week, I started a position in Lululemon and it will be the topic of my next deep dive after PayPal is published. For this issue, I wanted to provide a condensed (I promise) view of what I see in the company that excites me as well as my path for building the position. For my Shopify overview, there was pushback for how long it turned out to be. I’m going to do my absolute best to keep this overview short, sweet and still packed with information.
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a) Basics
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Lululemon is an athleisure apparel company with roots in Canada. The vast majority of its sales come from direct to consumer e-commerce and owned-stores which both serve up key company benefits for the firm such as holistic access to its 1st party user data to help guide product releases. In my now biased view, Lulu has a chance to join Nike and Adidas in terms of ubiquitous global clout and presence. And while there’s a several years-long way to go to get there, it’s that process playing out which would provide immense potential shareholder value.
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b) Performance
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I view this company as a high probability 15% revenue compounder for the long term -- which is where its team has guided revenue growth for the period 2021-2026. In 2018, Lulu offered long term 5-year targets that it eclipsed ahead of schedule across the board by several quarters to give an idea of its ability to overdeliver. And the runway is quite long. Lulu estimates its total global addressable market opportunity at $650 billion with its 2021 annual revenue representing around 1% of that. Since 2019, it has shown a keen ability to take more incremental market share within adult active apparel than any other company. So the opportunity is immense and Lulu has taken advantage since its inception.
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![image](https://cdn.commonstock.com/9aab31d76e762f9da84cc6eeea7f527768d0b5b7166fb7947c14f56acd60dc0d-278x157.png?fit=max&w=704)
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The Canadian firm has broad unaided brand awareness across North America, but carries very little clout internationally. Still, it has compounded international sales comfortably above 30% for the last several years with roughly 30% annualized growth expected to continue through 2026 as it gains brisk traction. There’s a large cohort of customers especially in Europe and China that should naturally be drawn to a brand like this -- so far, so good with much more work to be done.
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In terms of margins, performance here has been largely positive as well. The company’s selling channels are inherently higher-margin than wholesale endeavors, and so it boasts a lofty gross margin for a retailer. Specifically, this metric eclipsed 58% during the heat of pandemic tailwinds but has since cooled back off towards 53% -- still strong and better than most in its space. Just 11% of its sales are via “other” vectors which include lower margin wholesale.
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Since Lulu’s 2018 analyst day where it offered the targets it easily beat, the company has compounded earnings and revenue at 27% and 24% respectively. As a result, margins have gone up with operating margin specifically reaching a robust 22% -- and expansion is expected to continue through 2026. Interestingly, the company’s owned stores boast its best margins out of any selling channel as its complete vertical integration allows it to command a larger chunk of the profit pie. These owned stores possess an operating margin pushing 26%, and as brick and mortar shopping returns, that could push unit economics higher with owned-stores becoming a larger chunk of total sales. Impressively, comparable store sales soared 24% YoY last quarter on the heels of some difficult comps with store productivity re-surpassing pre-pandemic levels. That was wildly impressive to me especially considering it’s despite China -- representing 15% of its total stores -- shuttered during the period.
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Furthermore, in-store and e-commerce shopping both effectively raise a customer’s engagement with the other Lulu selling avenue. For example, its e-commerce conversion rate has risen 10% over the last few years with credit given to its omni-channel proliferation. This engagement juicing also comes without more customer acquisition cost making it an inherent margin tailwind as well. I’d just like to point out here that Lulu’s margins are already comparatively excellent. There may be a tad more margin expansion to come, but it will be subtle and that’s entirely fine with me as long as compression doesn’t become an issue.
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In terms of capitalization, the balance sheet is a strength for Lululemon. It has $1.3 billion in cash with another $400 million in current liquid assets plus zero debt. It bought back $813 million, or a little over 2%, of its shares in 2021 which represents a doubling pace vs. the previous 3 years. It’s leaning in here as its stock gets shellacked.
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c) Future Opportunities
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1. Global expansion where brand awareness leaves ample room to run.
2. Expansion into sports like Tennis. It recently signed the 15th ranked Female tennis player in the world (Canadian Leylah Fernandez) as its first ambassador for the sport. Intimate partnerships with the Canadian Olympic Committee helps here as well.
3. Experiential stores & pop-up shops creating service-oriented use cases. This contributes to the added benefit of juicing revenue per user by 15% when they sweat more.
4. Membership programs which launched in fall 2021 to drive loyalty and engagement. For example, its Pinnacle membership involving “MIRROR” offers access to bountiful on-demand remote fitness content and early access to new gear.
5. Footwear!
6. Collaborations with iconic brands like the University of Michigan to create a dedicated apparel line for its half-million living alumni and 100,000+ students. Go Blue.
7. Differentiation through new material creation. Its “Science of Feel” platform is a key focus for creating utility building, proprietary fabrics for its apparel. Depending on the legitimacy of these claims, this could provide rare differentiation within a commoditized industry. For example, its air support bra is the culmination of 5 years of research to help women with their yoga poses.
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d) Leadership and Hiring Trends
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The company’s founder is no longer involved with Lululemon and has a somewhat colorful history. I’ll cover that in the deep dive but for the sake of brevity will focus on current leaders here.
1. CEO Calvin McDonald: Disney Board member; Former Sephora and Sears Canada President; 85% Glassdoor rating.
2. CFO Megan Frank: Sachs Board Member; Former Finance VP at Ross and J Crew.
3. CTO Julie Averill: Former CIO at REI; Former VP at Nordstrom.
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Hiring Trends Via LinkedIn
1. Headcount is up 25% over the last 2 years with engineering headcount growth leading the pack by a wide margin at 32% growth.
2. It has hired around 2,000 new employees since the start of the year but headcount growth has recently slowed.
3. Average tenure is 2.5 years -- not great or terrible.
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e) Risks
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The main risk for Lululemon is shorter term macroeconomic volatility. Today’s economic cocktail of record low consumer confidence, generational high inflation and tanking savings rates will all inevitably weigh on discretionary spending. For a firm like this one which caters to a generally affluent shopper, it will be somewhat insulated from this pain, but certainly not immune. Macro creating more fragile customers also could present another possible issue: Shoppers flocking to cheaper brands. There are countless companies playing in Lulu’s space and most come at a lower price point. So as wallets are stretched, those fringe customers who can just afford a Lulu shirt may gravitate to a Gymshark shirt at half the price. I think Lulu’s superior quality will allow them to be somewhat resistant to that phenomenon, but we’ll see.
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We also must consider hectic supply chains as a risk for retailers most effectively matching supply and demand. Many of the largest have struggled to do so, but Lululemon’s vertical integration surely provides timely support here. Again, it’s resistant here, but not immune.
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This team has also not done all that well with M&A. The MIRROR acquisition could very well eventually be written all the way down as it jumped into a faddish trend at the heat of the pandemic. Thank goodness it didn’t try to buy Peloton. I still think MIRROR can enhance Lulu’s overall omni-channel value proposition but this deal is not off to a great start and it surely overpaid when playing Monday Morning Quarterback with the luxury of hindsight.
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Finally, athleisure got a somewhat large boost from stay-at-home orders. No longer did employees have to wear a suit to work, and many embraced Lulu’s apparel niche as a result. Was that the reason it was able to reach its long term targets so soon? Or will the momentum be more sustainable than that? Work from home is not totally going away and Lulu had been compounding long before Covid-19 entered society’s vocabulary -- so I’m optimistic, but time will tell.
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f) Expectations and Plan
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At 26.8X NTM earnings, Lulu trades right at its 5-year earnings multiple average of 27X. At these prices, I think a few things are true. The deal is compelling enough to start a position and there could also very well be more downside ahead. Specifically, 21X forward earnings looks like it will offer Lulu’s stock with significant support and I’ll use the 21X to 27X multiple range as a guide to filling out my position. With this in mind, I started VERY small with just 18% of a full position. It’s always a marathon and never a sprint, but today that may be even more true.
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Furthermore, the earnings estimates for Lulu and public companies could be coming down over the year as the economy weakens. I would point out that Lulu has a wonderfully consistent track record of beat and raise, just boosted its own estimates last month and has seen analyst estimates rise accordingly, but these are unprecedented times.
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Based on my preliminary research into the company and historical results, I think the following 5 scenarios encapsulate where Lulu could be in the next 5 years. I would point out that estimates like these include several rough projections making accuracy a rarity. Please take this with a large grain of salt. Results could surely vary and I do try to lean pessimistic whenever possible when building these models.
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Don’t forget the fashion risk. What if athlesiure isn’t cool to wear in 5 years and lulu can’t successfully pivot to whatever is. That is what has held me back from starting a position, despite my wife’s insistence, to our detriment so far

Love the products. I got everything in their mens section in  black. Their logo is discrete, and it’s great for working out, playing golf, lounging at home, and they have lightweight/breathable/comfy business casual clothes to wear to the office, so you won’t want to go back to fabrics in traditional formal wear. Also their items hold up well after multiple wash/dry unlike cottons shirts that get faded

hypescaleflow

Undefined

Nice pick! I’ve always kept tabs on LULU, can’t wait for a similar post when you join me in $CMG 👀🙂🌯

Sean

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