Lululemon: Making The Next Nike
Summary
- In 2018, Lululemon announced a 5-year plan to double its menswear revenue and quadruple its international revenue by 2023. It has been executing this plan successfully.
- The company has set about on a path that seems to be oriented towards "sustainable growth" instead of "reckless growth at all costs".
- This should be extremely heartening to shareholders.
- The company's success in international markets, namely China, also portends share price appreciation in the future.
- I rate Lululemon a hold presently, though long term, I am bullish on the stock.
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Source: Lululemon's 2019 Analyst Day
Investment Thesis
Lululemon (NASDAQ:LULU) is an athletic retailer that employs a "premium pricing model" in which the company creates desire for its products through relative scarcity and higher prices. As we all know, this model has seen immense success for companies, such as Apple (AAPL) or Tesla (TSLA). To this end, the company has positioned itself as the leader of the secular health and wellness trend through its well-designed products and winning brand strategy.
Source: Lululemon's 2019 Analyst Day
As can be seen above, Lululemon believes that there is a $3 trillion global wellness market on which it can thrive. The company has historically focused on making women's yoga and athletic wear, which has been very successful and will continue to drive revenue for the business.
However, the company has its sights set on diversification of revenues and the conquering of international markets. Such a focus should prove to be a winning strategy, whereby the company will derive further growth, and therefore, drive the share price (and free cash flow per share) higher.
Today, I will explore the progress of these new revenue-generating channels; after which, I will provide a valuation for the company.
Source: Lululemon's 2019 Analyst Day
Lululemon's Appeal to Men
While brands like Nike (NKE) and Under Armour (UA) have been historically menswear companies and are currently focusing on targeting female customers, Lululemon has been historically a women's brand and is now focusing on men.
And the strategy seems to be working. Lululemon offers the best of both worlds: extremely comfortable clothes that are designed as activewear but intended to give a casual look, so it's natural that anybody should like them.
For example, the ABC pants are innovative and have been a bestseller (if you're not sure what ABC stands for, click the link). The pants are comfortable and can be worn to work, the gym, or out on the town, and this is a concept that applies to most of Lululemon's apparel.
In 2019, Lululemon saw a 34% increase in men's revenue and plans to double its 2018 men's revenue by 2023. In 2017, men's revenue generated $526.5 million in revenue and $933.8 million in 2019. The company has taken strides in the men's market, and this is partly because Lululemon accesses this channel through its female customer base.
In a 2019 interview, Lululemon COO said, "about 40 percent of our men's product sales today are to women". Women are an important catalyst for the business since they introduce the "sweatlife" to this new market. So while Lululemon grows and promotes its men's market, it will also look to expand internationally.
Source: Lululemon's 2019 Analyst Day
Through 2018, Lululemon had strong growth in the U.S., and it will look to quadruple its 2018 international revenue ($360 million) by 2023.
Plans For International Growth
Lululemon increased international revenue by 32% in 2019, which is on track with its 2023 goal. In Lululemon's five year plan, it plans to focus on capturing the markets in Europe and Asia, as can be seen below.
Source: Lululemon's 2019 Analyst Day
In 2019, Lululemon opened 24 stores in Asia-Pacific and eight in Europe. It also expanded its e-commerce markets to Japan, Germany, and France. Lululemon separates itself from other retailers by offering a highly sought after premium product that is simultaneously configured such that it targets specific regions.
We could think of Lulu's products as iPhones. That is, the more expensive they are, and the more scarce they are, the more desirable they become. They are in the sweet spot such that they aren't Louis Vuitton (LVMH) expensive, but also aren't cheap and mundane.
Source: Lululemon's 2019 Analyst Day
As can be seen above, the China market is a key market for Lululemon's international expansion. In Lululemon's first quarter of 2019, sales in China spiked 70%.
To achieve this level of explosive growth, Lululemon has focused on catering to its customers, especially in China and Japan. The company uses local models and, as I mentioned, tailors its products for specific regions. Its products have been received very well, as evidenced by the above revenue growth, in China, and this reception signifies the connection that the brand has with its customers.
Now that we've discussed Lululemon's expansion into international markets and the success thereof, let's check out how the company has been developing its digital marketplace.
The Digital Marketplace
In 2019, 28.6% of Lululemon's revenue came from digital sales, which was 32% higher than the previous year. Lululemon plans to double its 2018 digital revenue by 2023 to over $1.7 billion.
Source: Lululemon's 2019 Analyst Day
As there are under 500 stores, Lululemon must employ its omnichannel strategy to access customers in regions without physical retail stores.
Now, let's see how the company is performing financially.
Financial Analysis
The company's gross profit margin increased to 58% by 2020, and the company plans to continue to develop its product and utilize digital sales to increase its margins.
Source: YCharts
Lululemon increased its free cash flow per share, which is a good indicator that the company is in good health. The company has a little over $1 billion in cash and equivalents; so it can sustain further complications from the Coronavirus.
Lululemon moved production away from China due to Trump's trade tariffs, resulting in an increase in margins. This has given Lululemon a diverse vendor base and contributed to the company's higher profit margins since 2015. Lululemon CFO P.J. Guido said in an interview,
"We've never had more flexibility than we do today in our supply chain. So going forward, we do not expect it to be a big impact to the business."
This is going to be essential going forward as the company now has a strong supply chain that doesn't entirely rely on China.
L.A. Stevens Investment Model
To determine a fair value for Lululemon's stock, we will employ our proprietary valuation model. Here's what it entails:
- Traditional discounted cash flow Model using free cash flow to equity discounted by our (as shareholders) cost of capital.
- Discounted cash flow model including the effects of buybacks.
- Normalizing valuation for future growth prospects at the end of the 10 years (3a.). Then, using today's share price and the projected share price at the end of 10 years, we arrive at a CAGR. If this beats the market by enough of a margin, we invest. If not, we wait for a better entry point.
Now, let's check out the results!
Assumptions:
Assumption | Value |
Free cash flow per share | $7.63 |
Free cash flow per share growth rate | 13% |
Terminal growth rate | 2% |
Years of elevated growth | 10 |
Total years to stimulate | 100 |
Discount Rate (Our "Next Best Alternative") | 9.8% |
Source: L.A. Stevens Valuation Model
According to the L.A. Stevens Valuation Model, Lululemon is currently about 20% above its intrinsic value from a conservative DCF perspective. However, this does not paint the entire picture.
Margin Of Safety
Lululemon is targeting low teens CAGR through 2023, which is very positive. That is, the company is targeting sustainable long-term growth that won't cause the company to implode. With that being said, the company seems unable to control (a good problem to have) the massive demand for its product, as evidenced by Lululemon's revenues increase of 21% in 2019, and 24% in 2018.
Source: Lululemon's 2019 Analyst Day
As can be seen above, Lululemon has expanded greatly over the last ten years, and based on its expansion into menswear and international markets, 13% growth will likely prove to be conservative. But in the interest of implementing a margin of safety, we must be very conservative in our assumptions, such that we can be very wrong and still be right.
Total Expected Return
- Therefore, I presently rate Lululemon a hold, as it does not exceed our hurdle rate, or our required rate of return, i.e., the average annualized return of the S&P 500 Index Fund.
Concluding Thoughts
In sum, Lululemon is a brand of the future. From my perspective, there's a chance the company one day rivals the likes of Nike. So long as the brand continues to grow sustainably and moderately, i.e., doesn't flood its target markets, it will offer compelling value to consumers.
Its management seems to understand the idea of moderate, though sustainable growth, which Under Armour's management seemed to have flouted, resulting in the financial destruction we're seeing in the company today.
I rate Lululemon a buy at $250 and below.
As always, thanks for reading; remember to follow for more, and happy investing!
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This article was written by
Some credentials of mine: Former U.S. Army Officer, Political Science Florida Atlantic, MBA University of Florida, inventor of the L.A. Stevens Valuation Model.
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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