Lululemon Athletica: A Strong Mission Can Overcome Adversity

| About: Lululemon Athletica (LULU)

By Jharonne Martis

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A year ago, Lululemon Athletica Inc. (NASDAQ:LULU) looked like it needed some of the deep breathing exercises popular in yoga classes. We covered its recent problems here. Now, we analyze how the company has emerged with new life.

As CEO Potdevin said, we had a "very successful holiday season." Indeed, Lululemon posted stronger than expected Q4 results: earnings were up 9%, revenue rose 16.9% and Same Store Sales were up a whopping 11%. It continues to outperform the apparel industry for the most part (Exhibit 1). As a result, the stock is soaring. One interesting factor is that the bulk of its revenue is coming from its actual stores, in a time when other brick-and-mortar retailers are struggling to cope with more online competition.

Exhibit 1: Lululemon Outperforms Apparel Sector Same Store Sales

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Source: Thomson Reuters I/B/E/S

Purpose-driven business

Even though Lululemon operates in a fashion industry, the purpose behind its business is to promote wellness and a healthy lifestyle. Its mission is one that can be found on its red shopping bags: "Creating components for people to live longer, healthier, fun lives." The retailer's manifesto reads, "We are passionate about sweating every day and we want the world to know it. Breathing deeply, drinking water and getting outside also top the list of things we can't live without."

Lululemon has proven that its success, brand perception and value are just as dependent on its product, leadership and yoga culture. Despite the see-through pants fiasco, customers stayed true to the brand because of its message, communication and actions. Today, Lululemon has a stronger brand name and loyal customer base - which has helped it through difficult times.

The mess also inspired major changes at the company, making its supply chain more responsive. Below are a few actions that helped the company keep going without losing its passion, overcome a massive amount of negative press and remain a prominent brand:

  1. Quick Turnaround

Lululemon took immediate action to remove the problem, upon discovering the pants were defective. All affected items were pulled instantly from stores, as well as inventory of the same styles that were in transit. The same was done with merchandise that was still in the factories and under production. After pulling the black Luon fabric pants from their stores and fixing the quality control issue, the company was able to re-stock the stores within 90 days.

The see-through pants problem cost approximately $67 million. However, the retailer apologized, announced that integrity is key and it was ready to make tough decisions to remedy the situation. As a result, the retailer looked like a leader in quality control, commercialization and development, improving quality consistency and delivery capabilities (Source: LULU Earnings Call 3/21/2013).

  1. Customer Engagement

Lululemon supported customers and kept them engaged with the brand. Its Metta Movement is one way it keeps engaged with its grassroots community by funding projects that contribute to social and environmental health. By listening to customers and going through the recall, the company also said, "The silver lining to this crisis was the big leap forward in our transition to owning our own technical standards and expertise." (Source: LULU Earnings Call 6/10/2013).

  1. Selective Workforce

Lululemon hires management that fits its core socially conscious philosophy. Its employees were loyal customers who identified with the lifestyle before working at the store. What's more, they share the company's purpose and culture with other shoppers. Meanwhile, back in 2014, the retailer hired Laurent Potdevin as its new CEO. Potdevin comes to Lululemon from Toms Shoes, which makes him a strong cultural fit for the yoga retailer. He has 25 years of experience at Burton Snowboards Inc., which is also a successful activewear brand. His experience at Toms Shoes shows he has worked with a brand where quality, culture and social awareness are important. Since Lululemon targets affluent women, Potdevin's experience at LVMH is a plus. For international expansion, including Asia, the retailer hired Jennifer Battersby, who led Victoria's Secret's Asia expansion.

  1. Community-based Sales/Marketing

Lululemon marketing includes a brand ambassador program that features famous athletes. It also has established strategic partnerships with local supermarkets (including Whole Foods (NASDAQ:WFM)), spas, health clubs and yoga organizations. Shoppers can take complementary yoga classes at their local Whole Foods. It also sponsors selective festivals including Wanderlust, where yoga lovers gather and learn from the best teachers and inspirational lecturers.

  1. No Discounts

Lululemon rarely discounts its products, even in today's promotional environment. No discounts mean staying true to brand image, selling the illusion of brand exclusivity. In fashion, athleisure is here to stay. In fact, Lululemon sees it as such a strong trend that it did not run any cyber Monday ads and very few holiday promotions. In a time when retailers are proffering deep discounts to lure shoppers, Lululemon does very little, nor did other popular athletic brands including Nike. They don't have to. Athletic gear and apparel are selling well at full price and footwear stores saw big crowds this past crucial holiday season.

  1. Profit by Association

Other complementary segments within the healthy lifestyle category have also benefited from the athleisure trend as well. Since the trend's success, we've also witnessed the birth and growing popularity for healthy lifestyle consumer electronics such as health apps, Fitbits (NYSE:FIT) and wearable technology.

Meanwhile, in Paris, a city known for the ultimate luxury and haute couture fashion shows, designers started sending athleisure fashion down the runway. Net-a-Porter includes upscale yoga wear from Fendi and Jason Wu with prices ranging to over $400 per piece.

Because of the strong trend, the activewear industry continues to see more exciting athletic designs and players enter the field - designers Rebecca Minkoff and Derek Lam, Fabletics by Kate Hudson and Yeezy shoes by Kanye West.

Luxury brand vs. mass production

Only a few luxury names can grow their brand without losing the risk of diluting it by over-saturating the market. When it comes to luxury, the perception of being exclusive is everything. However, some luxury brands did fall victim to the great recession, a time when consumers were drawn to promotions and discounts, followed by merchandise selection and product quality.

Shoppers started to trade down and off-price retailers were making all the revenue from consumers wanting designer clothing for less. As a result, high-end designers started creating lower-price point collections to appeal to the masses, aligning themselves with websites like HauteLook, which sells high-end designer clothing at discounted prices.

Designers such as Ralph Lauren, Tommy Hilfiger and Calvin Klein were once considered all-American upscale brands. Then they started to license their names to everyone and everything, and lost some caché. Take Tommy Hilfiger - back in the 1990s, the retailer was the cool label worn by the music industry. Today, it has some standalone stores/outlets but its merchandise is mainly sold at Macy's (NYSE:M), targeting middle class consumers. Speaking of Macy's, this iconic retailer will be closing several of its department stores around the U.S.

Similarly, Coach (NYSE:COH) and Michael Kors (NYSE:KORS) - also once considered high-end - started opening more outlet stores and showing up everywhere. Analysts polled by Thomson Reuters have been concerned that Coach might be relying too much on outlet sales to generate revenue, which has been hurting profits, and also suggests that the pricing for their leather goods might not be right. The retailer kept opening outlet stores and offering many discounts, which tarnished the brand's luxury image. Coach also lost some market share when it was renovating its stores.

Michael Kors also started to put its name on everything, appearing in all department stores and saturating the market. As a result, its stock plummeted. All this has diluted these once lavish brands.

PVH Corp. owns Tommy Hilfiger, Calvin Klein and Michael Kors brands, among others. According to StarMine, PVH is in the bottom decile with the Price Stock Momentum Model suggesting price stock momentum is not in the company's favor. Additionally, the StarMine SmartRatios and Structural Combined Credit Risk (Pending:CCR) model scores correspond to an implied credit rating of BB-.

Exhibit 2: PVH Corp. StarMine Models

Lulu chart 2

Source: Thomson Reuters Eikon

Brick-and-mortars

Lululemon continues to invest in social media and benefits from the hot athleisure trend, but the store concept has been key to its success, especially in a time when brick-and-mortars face strong e-commerce competition. Perhaps a lesson other brick and mortar retailers can learn from Lululemon is how they attract consumers through their concept and strong sense of community. Upon entering the stores, shoppers enter a community where free yoga classes are offered, and a community that embraces wellbeing.

Lululemon was founded in Canada in 1998, when Chip Wilson opened a yoga studio in Vancouver, British Columbia. The bulk of its revenue (70%) is generated in the U.S., with one-quarter of its sales (24%) generated in Canada (Exhibit 2). What's more, 75% of revenue is generated within stores, not online. Lululemon also understands that millennials make up the biggest population group in the U.S. and Canada and effectively targets this group.

Exhibit 3: Lululemon Revenue by Segments

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Source: Thomson Reuters I/B/E/S

Room to Grow

"As our momentum continues to build, we are excited by the progress made with our international expansion, the launch of our new women's pant wall last week, and successful brand-building events occurring around the globe" (Lululemon earnings call, 9/10/2015).

Lululemon is incorporating trendier looks with fun patterns, and expanding its offering to the entire family. It also opened a Lululemon Lab concept in NYC geared toward office clothes and is expanding its offering to the entire family. Its Ivivva brand targets girls aged 6-14 and its men's selection continues to appeal and grow as well.

However, the competition isn't standing still. Gap's (NYSE:GPS) Athleta is known for opening stores in the vicinity of Lululemon, making it easier to steal some of Lululemon's core consumer - especially when offering lower prices. They recently announced that they will also start offering Athleta Girl, a collection targeting the same 6-14 age group. The collection will be available this summer.

Both retailers acknowledge that athleisure is a trend that is growing as mom, her sisters and friends are wearing fitness gear, and are all becoming more active. Moreover, the retailers say that the collections are a way of empowering girls through sport and fitness. Meanwhile, millennials aged 18-33 have been drawn to Lululemon's socially responsible efforts. They see it as a way of contributing to a company that makes the world a better place.

Additionally, the retailer continues to expand stores in Europe, America and Asia. The illusion of exclusivity has worked well in Asia, especially with Chinese consumers that once used to come to Hong Kong to shop for upscale purses. Rich mainland Chinese shoppers are now traveling to Hong Kong for upscale athleisure fashions. Hong Kong luxury malls that carry LVMH also carry Lululemon now. Its latest store is estimated to generate over $8 million in sales alone this year.

High-end sports are cashing in on the hot trend in Asia, especially since the Winter Olympics will be in Beijing in 2022. Luxury sports gear is on demand for mainland Chinese shoppers, who are increasingly running more marathons. Adidas (OTCQX:ADDYY) is opening a major retail store in the heart of downtown Hong Kong, where luxury maker Coach used to have a huge store. The full Reuters story is here.

Exhibit 4: Lululemon Number of Stores

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Source: Thomson Reuters Eikon