Lululemon Athletica: Heading for Single Digits

Do Canadian retailers deserve Chinese Internet valuations? Lululemon (LULU), a specialty retailer of yoga inspired athletic wear based in Canada, is the most overvalued stock in the retail universe, even at the current sharply discounted price. Having traded as high as $70 a share, the common is now at about $30. But even at the current lower price, the forward PE is about 45.

How does that compare to some other specialty retailers? Under Armor (UA), also sharply down from a previous high and now trading at about 35, is trading at a forward PE of 25. Another former apparel darling, Crocs (CROX), is trading at a forward PE of 15. The lesson to be learned here is that the retail momentum crowd is exceptionally fickle, and, once a company disappoints on earnings, or offers less than shining guidance, the stock gets punished brutally. Other metrics tell the same story; price/sales are 9.6, the industry average is 1.0. Price/cash flow is 78; the industry average is 12. The dominant retailer in the athletic space is Nike (NKE); it trades at a forward PE of less than 15. LuLu’s net income for the quarter ended October 31 was $11.2 million, yet it has had a market cap north of $5 billion dollars at its peak.

LuLu has 70 stores, and at the current market cap of $2.8 billion, each store is valued at about $40 million; that’s phenomenal. I’ve been in several of these retail locations, and they’re just fine, but nothing unusual; we’re talking about perfectly conventional retail sales outlets, both in malls and street level retail; the sizes of the retail locations are very modest, perhaps 1,000-2,000 square feet or so; there is absolutely no barrier to entry in establishing this retail channel, which forms the bulk of Lulu’s sales. Also, this market can easily be entered by others, Victoria’s Secret has announced plans to do so.

If you visit LuLu, you’ll also find that the items are very expensive; I haven’t found anything, even a tee-shirt, for less than about $60. Compare this with Under Armor, which sells many of it’s shirts for around $20. While very expensive and trendy yoga inspired apparel will appeal to a small cult following, the question is how big that following can grow outside a few very trend conscious cities like Los Angeles and San Francisco? The entire market cap assumes hyper growth and new store openings. But with recession clouds gathering, how large is the market for people buying very expensive exercise apparel? There are certain things that women will not cut back on, such as makeup and skin care. But one would assume that high end exercise apparel would be one of the first discretionary items to go as households cut back.

There is also the whiff of something just not quite right at LuLu. As reported in previous posts on Seeking Alpha, insiders pocketed 78% of the proceeds of last year’s IPO, rather than investing these funds in the growth of the business, making a clear statement about what they thought about the company’s future prospects. The company makes the very new age, and completely unverified, claim that the materials that are incorporated into the fabrics, such as silver, have health benefits. For instance, you can visit their web site to learn about a very simple looking tee-shirt that is promoted as using “Silverescent technology using X-STATIC, the silver fiber”. The exotic materials are said to directly release amino acids and vitamins in the skin while working out. Really? It might just as well be shown down the road that such materials are health hazards, or more likely, that the claims are just another form of quackery. In fact, as has been previously documented in this space and elsewhere, those materials claimed to be woven into LuLu’s apparel may simply not exist, as the New York Times discovered when it sent some Lulu items to independent labs for verification and found no evidence of a special seaweed fabric alleged to provide health benefits.

There are just so many gaps in this story; such as CNBC reporter unsuccessful Herb Greenberg’s attempts to verify the claims on CEO Bob Meers’s resume. And some of the numbers, like sales per square foot, seem too good to be true, based on my experience in the stores. Begging the question, can you trust the reported numbers any more than you can trust the content labels on the clothing, or the CEO’s resume, or the original investors’ time horizon?

On the 22nd LuLu was downgraded by BMO Capital markets to underperform. On January 15 Goldman downgraded the whole athletic sector due to recession concerns, and also cut the price target on LuLu. When this stock is trading in the single digits a few months from now, people will look back at the company’s history and wonder how this small collection of quirky yoga gear ever was valued for billions of dollars; we’ll all smugly say how we tasted, and then spit out, this lulu of a lemon.

Comments

[David Tsao]

I couldn't agree with you more. My wife told me about the LuLu store a year ago when we were crusing through the mall, and my first question to her was, "This store only sells yoga chlothes?" This stock turned up in my overvalued screen the other day, and I considered a short position so I asked one of my friends who has used their products what the deal was. This was her response:

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"1) Yoga wear is a fad that is dying with general public, only people practicing yoga will continue to buy and wear it
2) For those who really ARE into yoga, lulu clothing is the yoga gear of choice
3) If they expand to the US, I think they will really appeal to those already practicing yoga, so there is huge potential since it seems as though "everyone's" doing yoga
4) However, Yoga participants have peaked in numbers in my opinion. I think those drawn to yoga have already gotten into it by now and those who aren't into yoga will probably never get into it, so I don't see a lot of "growth" there after they've opened up their US stores and the yoga-ers have made their purchases.
5) Lulu got a mention in Oprah about a couple of months ago (always a good thing) promoting it as great lounge wear or casual wear .
6) There are tonnes of other yoga wear choices and brands although Lulu is the "elite" brand of yoga wear (not a good thing)
7) There is potential for them to continue to grow if they work on new and fresh styles. Right now they seem to be relying on the same basics.

As for me, I own two articles of Lulu that I bought in 2003. Do I see myself buying anymore lulu down the road? Doubt it - maybe one more item at most - I think they're too pricey"

[Mario Rizzi]

Dead on correct. I've been wanting to write an article about LULU for a while but never got the chance. You hit the nail on the head with this one.
At max the company would be worth about 5$ per share, but even then it would have to show strong growth prospects, which I don't honestly think it can sustain. Ridiculous. Very well written article.

[freddiemertz]

Neither of your examples, UA & CROX are retailers and neither has a business model that is vaguely close to LULU. Also, coming up with a per store value for a hyper-growth retailer is meaningless. It gives no value to the growth, when in fact, that is where nearly ALL the value is.

[Go West]

Writer has made some good points. However, as an investment manager who just happens to live a couple of blocks from the original store, I might have some unique insight. The Lulu store in Kitsilano Vancouver is something to be witnessed. Madhouse, is the word I'd use to describe it. Hundreds of shoppers and the stuff is flying off the shelves.

An upstart competitor called "Lotus Wear" setup shop right next door and that shop seems completely empty.

Lulu is on to something that is more than just a silly trend likes Crocs. Young women (and men) in my part of the world are truly buying into the "lifestyle" that Lulu is promoting. I see young women walking around everyday with their yoga mats to the studios in Kitsilano and sporting their Lulu bags carrying their lunch to work downtown. Maybe the yoga lifestyle will never catch on on the East Coast, but if it does Lulu will continue their Starbucks like growth.

15-20 years ago, nobody ever heard of Starbucks outside of Seattle & Vancouver. This will be an interesting story to watch. Management will be key.

[ralphg]

LuLu clothes are currently popular with this market segment: teenage girl figure skaters, as well as skaters aged 20+. LuLu hoodies, sweats, and so on, are pretty much de rigour dress uniform for skating practices and warmups.

[Hasib]

I am trying to short this, but neither TDAmeritrade or Etrade would let me do it.

[blah-blah]

Another lame fad like Crox, soon to disappear

Stores are pretty though....

[ballsschweaty]

You morons short LULU will be sorry. It's classic women's athletic apparel with a cache' not found anywhere else. Quality is A-1 and customer loyalty is unbeatable.

Yoga is not really the issue. How many idiots who buy Nike shoes actually wear the shoes for the intended sport?

Air Jordans at $185 a pop are primarily purchased by inner city blacks who walk around [Comment edited for abusive language. Commenter put on notice] with the shoes untied.

[mbaglio100]

ballsschweaty: "Air Jordans at $185 a pop are primarily purchased by inner city blacks who walk around with a pimp roll with the shoes untied."

Well, inner city blacks with pimp rolls aside, ;> , most of us who are actually paying attention have kind of figured out by now that spending money like it's going out of style is going out of style. When the customers of these stores finally have it hammered home to them that they can't borrow anymore on their devalued house, they're going to realize just how rediculous it is to pay $60 for what in three years will be the hippest car-waxing rag on the block.

[DanielJacome]

They have a cache, but it is not sustainable.

CROX and HLYS both had cache, they easily lost it.

As soon as sales decelerate (investors need to look @ the 2nd and 3rd derivatives of sales/expenses), LULU will blow up, just like those other high P/E has-beens.

No way 50 LULU stores = $2B market cap.

[thebigapple]

Interesting article, John. I can only assume you're either trying to short it like the guy who tried to prove there was no seaweed in the clothes, or just upset that you missed the IPO. Either way, it's not professional to lie about the company and what you think are the trends. I'm sure you are smart, but I don't think you do Yoga or have any idea what is going on in the health and fitness community...

(1) yoga is not a fad and will likely be required as part of school exercise programs across the country in the coming years because every study is showing it is one of the best forms of preventative medicine out there. You will see entire generations growing up with yoga.

(2) that said, forget about yoga - this store appeals to anyone who is interested in fitness - go to a store and you will find very high quality clothes that last a very long time and even more importantly, there are plenty of things under $60 and there are no $60 T-shirts.

(3) they have free tailoring - I don't know any store that has that.

(4) every single woman I've talked to who buys something there says it makes them look thinner and feels great. You cannot fight that, John, it's like the laws of physics....this stock will be at $70 at the end of 2009.

(5) in the same way entire generations are growing up with yoga, they are growing up with iPods, which when they first came out, were shunned because they were too expensive. You will be as wrong about LULU as Herb Greenberg was about Apple years ago...

[SunsetSurfer]

Lululemon is well positioned for global growth, hence the premium valuation. It really doesn't matter what they are selling, as long as it matches the exceptional customer experience. You can only put out amazing customer experience through a culture of continuous personal and company development. Very few companies in any industry have been able to create this type of culture. That is what you are buying when you own this stock - phenomenal, passionate people aligned with a mission.

So, why did the IPO only generate a small amount of capital for the company's piggy bank? Because Lulu generates plenty of cash to finance it's own growth. Very few capital intensive companies can grow at these rates while generating positive cash flow.

Don't get too intellectual about your preference for lululemon. Just look for yourself. Are more people wearing it and talking about how they love it? Are the stores busy? If you bought some for yourself, are you choosing to put the product on in the morning?

The answer is always right there in front of your nose, not behind your nose.

[Ezzyme]

Another Jones Soda.......