Lululemon Athletica’s Strong Brand Has Room For Growth, Bolstered By Its Strategic Acquisition

Summary

• Outstanding fundamentals vs large well-known peers.
• Unique community-based marketing.
• Capital lite ecommerce segment creates COVID adaptability.
• Relatively untapped market outside North America.
• MIRROR acquisition creates additional sticky revenue line.

Business Description

Lululemon Athletica (LULU) designs and distributes athletic apparel through its company operated stores and direct to consumer (DTC) ecommerce channel. Both channels are vertically integrated. Sales under “Other” are generated through outlets, temporary locations and warehouses. 

Founded in 1998 in Canada as a women’s yoga brand, LULU’s focus on community-based marketing and quality has led to tremendous growth. LULU now offers accessories and athletic apparel for all physically active demographics. Aesthetically appealing “athleisure” clothing is offered, which is worn casually as well as while exercising.

Solid Community Based Brand – The Durable Competitive Advantage

LULU has grown it’s brand through what it calls “community-based marketing” using ambassadors. According to an Evercore ISI survey of millennial and Gen Z “must have” brands, LULU scored 16% and 22% for millennial and Gen Z respectively as a “must have” brand, over double that of Nike and adidas.

Local store ambassadors – a community of runners, trainers, athletes, yogis. These ambassadors promote the brand through events, driving store traffic in the local area and using social media. Each store has its own ambassador.

Global ambassadors – better known athletes such as Chicago Bears quarterback Nick Foles and women’s global top 10 surfer Malia Manuel, who promote the brand through social media posts and LULU’s advertising channels.

LULU selects ambassadors who embody the “sweatlife”, meaning they want to "Sweat", "Grow" and "Connect". I believe their community events and use of lesser known local reps have led to the superior brand strength, as consumers can strongly relate to LULU this way.

Their website shows impressive multiethnicity in the ambassador base, helping to draw a range of consumers who are persuaded by the strong liking toward these ambassadors and social proofing through the events.

In September 2020, LULU expanded their membership programme to Toronto, and began the programme's second year in Denver, Chicago and Edmonton. This includes exclusive fitness experiences, limited edition products, 1 sweat class at a new studio every month for a year for $150 a month. The exclusivity strengthens the brand even more.

“Power of Three” Growth Plan

Product Innovation

LULU is expanding their merchandise range and is committed to maintaining and improving quality through gaining ambassador feedback, this helps them stay ahead of the competition and further grow their men’s apparel sales.

Omni Channel and Store Experience

LULU places equal weight on in store, community and online experiences when marketing and aims to integrate them.  Examples include a virtual waitlist for stores used to comply with COVID social distancing, and their annual SeaWheeze Half Marathon being presented virtually with over 23,000 attendees from over 100 countries. Other festivals include Sweatlife, held in London, Paris, Berlin and Mainland China.

This leads to a unique brand experience.

Market Expansion

Within North America, APAC and EMEA. LULU wants to quadruple international sales by 2023.

Store Experience

LULU’s stores connect consumers with its brand ambassadors, this interaction is important to the brand. In 2019 LULU opened 2 new “experiential stores” in Mall of America near Minneapolis and in Chicago, these offer exercise studios and healthy foods.

While the other stores are designed to be small and capital efficient, these larger ones with various tangible experiences will help attract new consumers.

Year	Stores	Store revenue ($m)	Same store sales ($m)
2019	491	2,501	5.1
2018	440	2,126	4.8
2017	404	1,837	4.5
2016	406	1,704	4.2

LULU opened stores in Malaysia in 2019, and they are on track to open 30-35 new stores globally in 2020. APAC and EMEA are the areas targeted. The number of stores in China has tripled over the past 2 years and their revenue rose over 100% q/q for FQ3 2021 (ending 10^th Dec 2020) , showing that LULU can grow as a global brand.

With only 12% of revenues being outside the US and the growing popularity of athleisure, there is potential for the international segment to expand.

Athleisure Industry

Physically active millennials will drive the industry growth according to Allied Market Research, who also wear the clothes casually. Style and comfort are key considerations.

Allied Market Research forecasts 6.7% CAGR from 2019-2026 in North America, over US GDP’s 10 year average annual growth of 2.3%. Grand View Research points to the increased acceptance of casual wear in the workplace as a driver for its 8.1% forecasted CAGR worldwide, as well as the other factors.

At home working as a trend will be a tailwind for LULU given their focus on comfort.

Given the mental and physical health benefits of fitness and the constant promotion via social media, as well as millennials accounting for a higher proportion of the US population by 2026, the outperforming growth seems plausible.

LULU vs Disclosed Peers

LULU has superior fundamentals vs its disclosed peers, partly thanks to its vertical integration. The brand remains strong as most sales are made through company owned stores that do not dilute the brands like department retail stores.

LULU still grew well during the pandemic, in part due to its ecommerce investments brought forward and digital marketing.

Store Numbers 2019

Company	US Stores	International Stores	Total Stores
LULU	305	186	491
adidas	177	1,013	1,190
Nike	240	695	935
The Gap	675 (includes Canada)	495	1,170
Under Armour	19	369	388

LULU’s small number of international stores vs peers shows the potential for expansion.

MIRROR Acquisition

During July 2020, LULU acquired at home fitness start up MIRROR for $500m in cash.

For $1,495 and a monthly membership fee of $39 per month, users gain access to a network of fitness trainers who they train with on the screen. Network effects result from group sessions, making the experience more social.

Reviews have been very positive. Currently only available in North America, the company plans expand it during 2021. They will also be used in stores as part of the omni channel experience.

In September 2020, management raised MIRROR revenue guidance from $100m to >$150m in revenue for FY 2020, demonstrating the success of the product.

Valuation

Scenarios for 2020-2022, revenue figures in $m, returns based on 26th January 2021 close of $329 (EV/Sales 10.6x):

LULU traded around 10.7-12.8x EV/Sales during Q4 2020, with a high of 13.5x in September 2020.

The estimates are conservative as:

• No growth in MIRROR assumed, which will happen as LULU expands the product internationally.
• Same store sales of $4.8m, this will likely be higher due to the growing popularity amongst men and new products.
• DTC growth of 30% per year after 2021, the growth was 32% for 2018-2019 before investments in fulfilment, improved web design and marketing for online in 2020.

Model with assumptions available on request.

Why I invested on 9^th November 2020

LULU had recently announced Q3 earnings, however the shares fell ~25% in early September 2020 due to management giving no revenue guidance for the year and not disclosing same store sales. This coincided with a market correction.

This was an overreaction as they reported revenue and EPS estimate beats. The business seemed resilient to COVID due to its DTC channel, allowing it to grow revenues by 2% q/q while peers’ revenues contracted.

What Could Go Wrong?

• Athleisure falls out of fashion, but given that it is practical for casual use and fitness this is unlikely.
• Nike or adidas try a similar community-based strategy, however their brands are based on excellence.
• MIRROR being a fad, but the success of Peloton's at home fitness devices defies this.
• As a consumer discretionary stock, there are cyclical economic risks.
• Relatively high valuation could involve large drawdowns, but quality companies come at a price.
• COVID lockdowns, leading to event cancellations and store closures, but I think this scepticism is priced in.