Lululemon, J. Crew: Specialty Retail Growth Opportunities

On August 4, The Wall Street Transcript interviewed Paul Lejuez, Director and Senior Analyst on Credit Suisse's retail research team with coverage responsibility for a total of 18 companies in specialty retail, including apparel, jewelry, off-price, homegoods, hunting/fishing, and fitness center sectors. Key excerpts follow: 

TWST: If we take a little longer-term look, are there growth opportunities in this space longer term?

Mr. Lejuez: Yes. I think domestically there are a few stories that we would say have very clear, visible square footage growth. That is to say, I can look three to five years down the road and see companies still growing.

One name that we would call out that has those opportunities is Lululemon (LULU), for example, which is in its infant stages of getting its store base established here in the United States after developing into a very well established brand up in Canada. They are just getting going here in the US. They've got about 80 stores right now split between the US and Canada, on their way to 250 pretty easily.

TWST: What's the market they're appealing to?

Mr. Lejuez: They sell yoga-inspired apparel, but they are not just selling yoga apparel here. They sell apparel that you can wear to pretty much any sort of physical activity. They do have specific clothing tailored for runners, for dance, for yoga, for pilates, and they really do a great job with not only the quality of their product, but they have a very good fashion sense. So what's happened up in Canada, for example, is that women tend to wear Lululemon clothing all day. They'll wear it to work out and they'll wear it to run errands; it's comfortable and it's very flattering for a woman to wear. They really seem to have established a nice little niche for themselves.

The other name I would mention would be J. Crew (JCG) in terms of growth opportunities here domestically. They have about 200 full-priced stores. We think there are about 350 "A" malls in this country, and so they could still increase their square footage at their core concept by over 50% over the next several years. There are very few companies that I cover, if any, that can say that. Lululemon would actually be way higher than that; they can triple or quadruple their store base, but J. Crew I think would be the other one that we would call out on the specialty side that has great growth opportunities.

TWST: What is it that gives Lululemon and J. Crew an edge that will allow them to succeed in a tough market?

Mr. Lejuez: Different answers for each.

With Lululemon, what they do so well is that they really become part of the community. They have a grassroots approach to marketing. They basically send in a team before they enter a market to open what they call a showroom, and what they do is they have people from the company who go out and meet yoga instructors in the area and they actually take classes at their yoga studios, which Lululemon pays for. So there ends up being this interdependency between Lululemon and the local yoga instructors, because in a sense, Lululemon is helping to pay the instructors' bills because their employees are taking classes there. And at the same time those employees are showing off Lululemon products and kind of spreading the word to the other people in the class about what Lululemon is all about and where you can get the products, and they explain that they are going to open a store pretty soon. It really turns into this viral kind of grassroots marketing where Lululemon stores become the go-to place in the community, in the sense that if women want to learn about yoga, where they can take classes, what they should be doing to stay fit — Lululemon really becomes the go to place for that.

With J. Crew, it's a little bit different. I think they operate in an underserved market, or I should say it's not served effectively, which is the young adults/adults market. They just seem to get the product right. They are run by CEO Mickey Drexler, and we'd say he is one of the few rock star merchants in specialty apparel. The way that they run their business is they've managed to put out some of the best fashion on the floor, season in and season out. They do a great job with colors. They do a great job with fit. They are always doing something new and interesting rather than just kind of sitting back and doing the same old thing. I think customers appreciate that, and they want to shop at their stores.

TWST: Is there a risk at J.Crew of being so dependent on Mickey Drexler?

Mr. Lejuez: Mickey certainly is key to the story, but President Tracy Gardner is there as well and I think that under Mickey's leadership she has developed into a very talented merchant. Nobody is going to ever be a Mickey, but I think she is one of the best out there.

TWST: Can Lululemon and J. Crew hold their own from a sales and earnings perspective during times like these?

Mr. Lejuez: We think they should be able to. Certainly, one of the things that drive earnings in retail is square footage growth, and these two have it. Lululemon has already shown that in this more difficult environment; their comp continues to increase very strongly, and I'd expect that to continue going forward. J. Crew has already shown that their same-store sales number has slowed a little bit, but I think it's important to look at their direct business as well, which represents about 30% of their overall sales, and that has been increasing and growing at a faster rate than retail sales have been. We did a report last week where we basically asked a question, "what if direct sales were included in comps?" and when we looked at our entire universe, J. Crew really stands out as being the beneficiary.

If we were, in fact, to include direct sales in comps, J. Crew's comp would have been 500 basis points higher. As far as we are concerned, as far as the company is concerned and the point we are trying to get across is that the direct sales should be included in the comp. There is very much an indifference, I think, between whether a company makes a sale at a store or online. Direct is a very leverageable, if not more leverageable model. So when you think about companies growing organically and being able to leverage their fixed investments, as far as I'm concerned the direct channel is just as important. Either ring the register or click the mouse. No difference to me or to the retailer.

TWST: The retailers don't do their accounting that way at this juncture?

Mr. Lejuez: The funny thing is it happens to be very specific to the softlines universe that they do not. If you look at some of the broadlines retailers, department stores and mass merchants, as well as the hardlines retailers, they in fact do include direct sales as part of their comps. The reason that we did this report last week was just to show that while everyone else is including it, our retailers don't and here is what it would look like if they did. And to take it a step further, this is how we think we should all be looking at it.

TWST: What kind of response did you get to that?

Mr. Lejuez: Most people wrote back that they agreed and that they thought it was a good point. It was very short, but it was also very helpful because everyone was able to see what comps would have been; we basically laid it out in some tables. So yes, the response was good and I think the companies certainly liked the idea.

 

Comments

[valueinvestor123]

I like J Crew, but there are not 350 "A" malls in this country. That number is ridiculous.

[sockhopper]

The Wall Street Transcript's interview entitled, "Lululemon, J. Crew: Specialty Retail Growth Opportunities" puts forward that Lululemon and J. Crew share a competitive edge and square foot growth. Based on answers given by the interviewee, this report concludes that these two companies share a similar growth potential. I am not an economist. But clearly, the interviewee is promoting Lululemon at a time when that company is trying to embed itself more deeply within the U.S. That these two very different companies who treat customers very differently are being treated in parallel in the same report shocks and disturbs me. There must be something very wrong with the formulae economists use to forecast positive growth potential. As long as customers are needed to conduct retail business, I would never put Lululemon in the same bracket as J. Crew , and my credit card supports my belief.

Lulelemon is a Canadian-owned company that since about 2005 has extolled certain health properties of the fabrics it uses for its yogawear. One 'seaweed' line was touted to contain 'stress-busting' and 'calming' amino acids on account of a 23% seawood compound added to its cotton and lycra fabric. In November, 2007, the New York Times had garments from this line tested by an independent lab when an investor alerted that paper to lab tests that he had had conducted and that revealed no discernible seawood component in this line of activewear. The lab used by the NYT reached the same result. This means that a Lululemon T-shirt is no different from any other cotton/lycra T-shirt. When apprised of these tests' results, Lululemon in Vancouver, Canada responded in a press statement that for the past year it had put this 'seaweed' fabric through rigorous testing and that the company stood by this product. At first, Lululemon's executive would not speak with the press. Within days, a Vancouver retail consultant opined publicly that Lululemon had to take responsibility for this product because the problem concerned more than just this one product as the company had been making unsubstantiated 'wellness' claims about all its clothing textiles. Shortly thereafter, Lululemon's founder and chairman, Chip Wilson, admitted to the New York Times that the 'seaweed' line of apparel contained no seaweed compound. Defensively, Mr. Wilson added, "If you actually put it on and wear it, it is different from cotton. That is my only test of it." Thus, by merely having decided to not test the fabric for a component that the company claimed had near mystical attributes that would be transferred to a wearer's skin and psyche, Lululemon created for itself an escape hatch from its social and business responsibility to inform honestly, and to take responsibility for its misrepresentations on both the fabric's composition and its 'rigorous testing'. This is a modern version of "The Emperor's New Clothes" that has exploited the trust of those who are into ecology and health through nature. When the Canadian press caught up with Mr. Wilson, he essentially pleaded for Canadians' pity. Canadians didn't like this. We are urged to buy whatever Canadian retailers provide us to wear and here was a relatively new all-Canadian company we were told we could be proud of. What we got was snake oil.

So, I laughed to read Mr. Lejuez, the interviewee in this article and Director and Senior Analyst of Credit Suisse's retail research team, saying, "With Lululemon, what they do so well is that they really become part of the community". By community involvement, Mr. Lejuez was referring to Lululemon's viral advertising through infiltrating yoga centres in order to sell clothing to patrons. This is community exploitation, not community involvement! What Lululemon needed to do was to respect truthfulness in advertising and take responsibility for its claims of special properties before it employed those claims as a marketing tool and before it lied about rigourous testing.

As for Mr. Lejuez' extrapolating from the fact that Canadian women wear activewear an opinion that Lululemon could engender excitement in the United States, this is not rational. Am I to believe that Mr. Lejuez, a senior analyst, did not uncover in his research why Lululemon was popular here? Or that he hasn't read the report of February, 2008 in MacLean's Magazine that cites a significant drop in sales here of Lululemon's products and activewear in general? He must know that we Canadian women wear activewear to all the wrong places because there is not much else here for us to buy! Our complacent retailers and dusty distributors refuse to source contemporary apparel of a mid-range quality and price for us. Our retailers labour their mantra, "Not here! You won't find that in Canada!" whenever we ask to buy a new trend that women in other countries are wearing. To prove that we are solid Canadians, we are not supposed to know or divulge that affordable contemporary clothing exists everywhere but here, even in South America and South Africa. We are not supposed to stop buying here just because retailers don't stock what we want. In response to the paucity of good clothing, some of us give up and resort to exercise clothing. But this situation is changing due to consumers' own efforts. Increasingly, more of us plan precisely routed shopping trips abroad to stock our wardrobes when we can afford this. And we shop internationally online which is a godsend. We do the sourcing that our retail specialists tell us is too much trouble to do. Even my postman has caught onto this. After one of his double shifts over the Christmas period, he asked me who "J. Crew" is. He'd just spent 10 hours delivering parcels to my tiny neighbourhood, and he noticed that almost every parcel was from J. Crew. I directed him to their website because he was excited about being able to find something really nice for his wife.

Mr. Lejuez ignored how badly Lululemon let down Canadians, and that we shop outside our country for real fashion.

Contrast Lululemon's disinterest in taking responsibility for its deceptive and downright fraudulent misrepresentations with J. Crew's commitment to its customers at all times and now during a major system change whose difficult birth is causing delays. Continually, J. Crew ensures that customers are correctly informed about its products' composition and construction so that we love shopping there. Their quality is consistently tangible, not imagined. This company doesn't evade problems; it corrects them. J. Crew regularly commissions factories to produce yarns and textiles to its express specifications and then monitors production. In this way, it proactively through its operations ensures that its customers cannot be misinformed or deceived.

If reliable truthfulness, and integrity and respect in its customer dealings form indicators of growth potential, then Lululemon does not compare favourably at all with J. Crew or other good U.S. sellers of adult clothing. So, how can Lululemon's growth potential match J. Crew's? And how can Lululemon grow in the U.S. after it has deceived Canadians and its sales have decreased here? If, instead, the prior behaviour of a company towards its customers is not accepted as an indicator of further growth potential, how then can a potential investor trust Credit Suisse's expert opinion on Lululemon's capacity to grow?