Note to Lululemon From a Potential Investor: Men Don't Buy 'Undies'

| About: Lululemon Athletica (LULU)

As anybody who keeps tabs on hot stocks undoubtedly knows, Lululemon (NASDAQ:LULU) has been pretty hot. Having been around long enough to know how high things like this can go, even if overvalued, I confess to considerable trepidation about yelling “Dog” . . . or uttering just the second part of the company name, “Lemon!” But I can’t resist doing it here. (I commented in response to a recent Seeking Alpha article and now want to elaborate.)

Let’s start with some numbers. The PE is 48 if we calculate it based on the consensus estimate of current-year EPS, and 40 if we use the estimate of next year’s results. The consensus long-term EPS growth rate is 25%. So depending on which PE you want to use, the PEG works out to 1.9 or 1.6.

That actually looks OK. Many believe PEG ratios need to be at or below 1.00. Actually, though, that’s nothing more than an investment-community fairy tale which has no basis in mathematics or financial theory. It’s a useful fairy and potentially lucrative fairy tale (it’s hard to argue when a fairy tale encourages someone to be more conservative than they need to be), but a fairy tale nonetheless. In practice, it turns out that PEGs approaching 2 can be fine even for value investors. (If readers are interested in an article on this topic, send me a message via Seeking Alpha). But to use PEG properly, it is absolutely critical that one think carefully about the growth rate being used.

At first glance, the 25% consensus for LULU seems plausible. Historical growth has been way above that so the 25% figure seems to allow for deceleration, as should be the case with any emerging growth company. But the tough question is how much deceleration we should assume and how quickly is it likely to occur. Consider that in its March 17th earnings release, LULU gave guidance suggesting EPS in the current-year will be $1.90-$2.00. The upper end of the range is 18.3% above last year’s $1.69-per-share tally. That’s already below the 25% long-term consensus growth rate! If we recalculate PEG using the 18.3% growth assumption (i.e. we’re assuming it will persist for a while and not continue to decelerate), we’d come up with 2.7 or 2.2 depending on which PE you want to use. Now, we’re up there. If 18.3% is just a way station on the path toward something in the 10%-15% range, the PEGs would look that much worse.

It is possible the guidance is too low. LULU seems to have done that before: Positive EPS surprises in the last five quarters (starting with the most recent) were: +12.7%, +43.7%, +25.7%, +29.0%, and +36.6%. Stockholders wanting to play this game (i.e., wink at what is assumed to be lowball guidance and celebrate when the company beats the consensus) need to note that the most recent surprise was the narrowest and contemplate what could happen to such a richly valued stock when the game finally ends (as it might even if LULU reports a favorable surprise, if the surprise is less favorable than many expect – don’t try to analyze the logic behind expecting surprises; there is none, it’s just a popular and dangerous game many investors like to play).

What about the potential for LULU to grow into its valuation? We’ve seen that before. Heck, I live with that sort of analytic framework every day with my low-priced stock newsletter! OK. Let’s give it a try.

The main part of LULU right now is selling yoga-oriented apparel to women, probably, but not necessarily, youngish women (I assume this based on my spectacularly unscientific observations of the kinds of women I see going into and coming out of yoga centers). The company’s web site also offers running apparel, but I suspect yoga is its true love. Figure 1, a screen shot from the e-commerce section of the company’s web site suggests that.

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Figure 1

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The postures depicted in the silhouettes are yoga poses, and the slogan is much more akin to something you’d likely hear at a yoga center, instead of on a running track.

There’s nothing at all wrong with any of this. I used to love doing yoga – a few decades ago when I could still force my body to get into and hold positions such as those depicted in Figure 1.

That’s an important point. Many people never have done yoga and probably never will. And even for a yoga-lover like me, I don’t do it any more. Ditto a lot of others who used to do yoga when I did. Actually, I’ve watched with a sense of nostalgic bemusement how the popularity of yoga has risen and fallen and risen and fallen etc. since I was into it. It may have been around for centuries, but in our society, it’s been a fad that’s come and gone many times no matter how deeply each generation of practitioner swore they were adopting a permanent lifestyle.

Maybe this time it will be different (although many might find some parts of the Lululemon manifesto a bit challenging, such as the one that suggests living near the ocean and inhaling the pure salt air that flows over the water; heck, I live in New York City and still don’t have time to go to the ocean all that often). But I don’t think I want bet my I.R.A. on that. I’m not buying into a 2-plus PEG for yoga!

I really think if one wants to be bullish on LULU, one will have to make a case that the company will succeed in broadening the brand beyond female yoga devotees.

STOP! Don’t scroll just yet to the comment area to tell me I’m an idiot for ignoring the fact that LULU already is about more than just yoga women. I know that and, in fact, I’ll search for clues as to the company’s potential for successful expansion, by looking at the additional markets it’s already pursuing.

I’ll start with men. This is an easy jump. We don’t even have to abandon yoga yet!

I’ll spare you the suspense and tell you right now that I don’t think this company has a glimmer of clue how to sell to men. I’ll start with Figure 2, which focuses on the men’s size chart LULU put on its web site.

Figure 2

I know there are no absolutes in this area, but suggesting that a 40 inch waist for a U.S. male is equivalent to XXL is, pardon, the pun, quite a stretch.

Going on, let’s look at the web menu in the men’s portion of the site:

Figure 3

Does anybody have a problem with any of this? Hint: Look at the fifth item under the “wear it” section. Hey Lululemon! Men wear boxers. Men wear briefs. Men wear underwear. But men don’t wear undies!

Believe it or not, it gets worse. Figure 4 shows a conspicuous-sized image that appears on the web page to which we’re taken after, cough, cough, clicking on “socks and undies.”

Figure 4

Does anybody have a problem with the slogan at the bottom of this men’s “undies” display? If you don’t skip it and focus only on Figures 1-3. I don’t want to make problems for the Seeking Alpha editors, so I’ll refrain from elaborating.)

OK. We’ve probably enjoyed a few good chuckles. Lets’ go back to thinking about the stock. My foray into Lululemon’s idea of men’s apparel was designed to give us an initial sense of this company’s potential to expand its brand in a way that will enable it to grow into the stock’s currently-high valuations. What I’ve done here amounts to just one glance beyond yoga apparel for women.

What do you think? I understand the number of men who actually buy this company’s undies is above zero. (I presume the 17 guys who reviewed them mainly favorably on the web site are for real.) But for a stock valued as high as this one, we need to see potential to garner a level of customer interest that’s considerably higher than “above zero.” So in that spirit, I ask: Are you impressed with the care and attention shown here by the company in this instance outside its traditional core market? I’m not. Actually, I’m flabbergasted by the level of thoughtlessness.

I know this is trivial in the context of LULU’s current business, which is slated this year to come close to the billion dollar sales level. But it’s not the current business that should interest investors. When the stock valuation metrics are where they are for a company with a very narrow niche, investors have to look at the firm’s potential to broaden its horizons.

This is just one clue (and I haven’t even considered how many men there are who actually want to buy anything that carries a brand name like Lululemon) but in grading it, I give the company a definitive “F.” Maybe LULU will get its act together. Maybe it will abandon men and look to grow more vigorously with women, but even here, it will eventually have to get beyond yoga. Right now, I’m not seeing anything that give me enough of a belief in the potential for success to make me want to pay more than 40 or more times EPS in order to own the stock.

In sum, Lululemon probably wishes investors would say “Ommmm.” I’d prefer to say “Oy!” Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.