Lululemon Sets its Sights on 'Blue Oceans'

While it may sound like a creative name for a new color of stretchy yoga pants, for Lululemon Athletica Inc. (LULU), “blue oceans” refers to untapped and uncontested markets. The description comes from a 2005 bestselling business book outlining how companies make the competition irrelevant.

Investors have an opportunity to invest in such an early-stage “blue ocean” company via Lululemon, says Blackmont Capital analyst Barbara Gray, who considers it an emerging player in the global athletic apparel market.

In addition to selling “innovative” clothing that is distributed exclusive through its retail stores, Ms. Gray highlights how Lululemon’s ambassador program and grassroots marketing have helped it build its brand and culture. This has led to US$1,400 in sales per square foot, compared to US$600 for competitors, pre-tax cash returns in excess of 50% in the first year at new stores and 100% in the second year, and an EBITDA margin of 21% versus a median of 14% for its peers, she said in a research report.

Ms. Gray also praises the company’s new management team and board, noting their strong track record and extensive network of contacts. As a result, she is confident Lululemon can achieve a compound annual growth rate of 41%, thanks to same-store sales growth of 7% and expansion from 52 stores to more than 200 by 2012.

But is the “blue ocean” sustainable?

New niche players and other established retailers are increasing competition in the yoga space. However, Ms. Gray says Lululemon’s brand approach, which avoids the use of models and celebrities, would be hard to replicate by major sports apparel companies since it would be a dramatic change for them. Its high-quality fabrics should also help Lululemon maintain a competitive edge, while its “almost cult-like following” is unique, she said.

While acknowledging that Lululemon is a premium-priced stock given that its value has increased tenfold in only a year and a half, Ms. Gray values its existing business at only US$5.71 per share, and estimates it is trading at a US$2.1-billion growth premium; she is nonetheless optimistic about its prospects.

She rates the shares a “buy” in new coverage, with a US$41.50 price target.