Lululemon, J. Crew: Specialty Retail Growth Opportunities

Includes: JCG, LULU
by: The Wall Street Transcript

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 (NASDAQ: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.