Lululemon Athletica inc.

+6.74 (+2.19%)
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How Lululemon Disrupted Everything But Now Faces Trouble


Lululemon Athletica Inc. (LULU)
67.26 +0.44 (0.66%)
Sector: Consumer Durables and Apparel
Published by Capital Market Laboratories on 2015-06-16

What does the rating mean?
3-Month Stock Move: +6.6%
6-Month Stock Move: +24.9%
12-Month Stock Move: +78.8%
30-day Option Implied Volatility: 29.1%
Implied Stock Range: ($62.80, $71.70)
What does "implied stock" mean?

Lululemon Athletica (LULU) has seen revenue (TTM) rise to all-time highs for nearly 30 consecutive quarters and now stands at over $1.7 billion. Researchers created the term "enclothed cognition" to describe the mental changes we undergo when we wear certain clothing. LULU has taken full advantage of that reality, selling premium priced under garments and Yoga pants in what have been coined "Wunder Unders." The firm has single handedly made wearing Yoga pants for daily activities not only normal, but hip. According to a study done by the NPD group, the activewear market grew 7% over the past year while general apparel grew only 1%.

LULU has caught some heat for its "see-through fabric debacle" in which the Taiwanese supplier claimed it was simply following instructions from LULU. Even further, LULU's founder, Chip Wilson, was quoted as saying "quite frankly some women’s bodies just actually don't work for [their clothes]." Well, there you go. The stock has found a very rough patch over the last two-years as have earnings, but the stock is up nearly 200% from May 2010 - May 2015.

One of the biggest concerns for LULU are its dropping gross margins. Here's a chart through time of gross margin %.

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Let's peak at earnings estimates for next quarter relative to last quarter's actual results, below.

Earnings Date EPS Revenue (Mean) Revenue (Median) Last Quarter (Actual)
2015-09-10 $0.34 $445.2 M $445.2 M $423.5 M Provided by ZACKS

LULU has committed to growing its product-mix, focus on international sales expansion and a sort of soft "improving guests' experience." All of this is in response to shrinking margins as the firm had found so much success at such high margins that in encouraged entrants (from companies like Nike and Under Armour). Given a lack of a true "barrier to entry" other than brand recognition, margin pressure is building and we will see that throughout this analysis. Keep all of this in mind as we walk through the fundamentals and make our way to the conclusion.

The first visualization I want to examine is a bit less myopic than the ones to follow. Let's compare LULU directly to Nike in one image across nine critical dimensions.

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Going across the rows, we can see that NKE towers above LULU in all three income statement measures of revenue, net income and revenue per employee. But of course that's the case, NKE is the giant. If we turn to row two, we can see that LULU towers above NKE in terms of gross margin % (even with the recent downward pressure) and net income margin %. In English, LULU has lower cost of goods sold and keeps substantially more revenue as after tax profit (~15%) than NKE (~10%). But that's starting to change.

Finally, the third row shows that LULU revenue is growing faster than NKE and the final chart in the lower right hand side shows how LULU has earned a price to sales valuation substantially higher than that of NKE from the equity market (4.9 vs. 2.8). In English, every dollar of revenue for LULU is worth ~$4.90 in market cap, whereas each dollar of revenue is worth only $2.70 in market cap for NKE.

Here are the core fundamentals that drive LULU's 3.5 star fundamental rating. You'll note it's a mixed bag with revenue, earnings and CapEx rising, yet operating margin and free cash flow are falling.

Fundamentals Rating Summary

Revenue (TTM US$ Millions) 1,836 1,630 1,430

Operating Margin (QTR) 1.191 1.22 1.32 FALLING

Net Income (TTM US$ Millions) 268 251 271 RISING

Levered Free Cash Flow (TTM US$ Millions) 129 160 163 FALLING

Capital Expenditures (TTM US$ Millions) 122 111 102 RISING

Stock Returns and Chart

LULU is up +6.6% over the last three months and up +24.9% over the last six months. The stock price is up +78.8% over the last year.

Before we dig into the fundamental trends that drive the rating, let's look at a two-year stock chart with regression channel and 10-day momentum (on the bottom).

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Now let's examine the visualizations of the critical financial measures.

Revenue (TTM US$ Millions) 1,8361,6301,430

As stated earlier, revenue (TTM) is trending higher meaning that it has increased for at least five consecutive quarters (in this case 30 quarters).

Revenue over the trailing twelve months (TTM) for LULU hit $1.8 billion, up from $1.6 billion a year ago, or a 12.65% rise. The two-year change in revenue (TTM) is $406 millions or a 28.36% rise. Suffice it to say that revenue growth is not the issue for LULU.

What do all these numbers mean?
LULU's fundamental rating benefited these results:
1. The one-year change was positive (but no extra points were given for a large percentage increase).
2. The two-year change was positive.
Finally, the up trend (consecutive quarters) in revenue benefited the fundamental (star) rating.

Let's look at Revenue (TTM US$ Millions) in the chart below.

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Net Income (TTM US$ Millions) 268251271RISING

Net Income (after tax profit) is also rising for LULU, hitting $268 million in the trailing-twelve-months. That's an increase of 6.6% in the last year, but, that's down from the all-time high of $279 million realized in the trailing-twelve-months ending in February 2014. Note that longer term trend, it's not trivial and does potentially represent a problem moving forward. It's that "margin" word again.

In our next chart we plot Net Income (TTM US$ Millions) in the blue bars and the quarterly results in the gold line.

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Levered Free Cash Flow (TTM US$ Millions) 129160163FALLING

Here's where it goes a little sideways for LULU. Levered Free Cash Flow (FCF) (TTM US$ Millions) is falling. It was $160 million a year ago, and now stands at $129 million (a 20% drop). Further FCF is down from two-years ago as well (it was $163 million).

For our next chart we plot Levered Free Cash Flow (TTM US$ Millions) in the blue bars through time.

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Capital Expenditures (TTM US$ Millions) 122111102RISING

Capital Expenditures (CapEx) (TTM US$ Millions) are actually rising and that expense is a part of the dropping FCF and broadly speaking dropping net income. CapEx is up 10% from last year's value of $111 million and 20% from two-years ago (when it was $102 million). Combined with lower gross margin %, FCF is shrinking.

In our final time series chart we plot Capital Expenditures (TTM US$ Millions) in the blue bars.

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The good news is that LULU made a new market that had huge margins and an equally huge consumer appetite. The bad news is that the market was easily replicated by other name brands and that has put a major squeeze on those margins. Nike and Under Armour are now squarely in LULU's market which means LULU must compete; a phenomenon it didn't really face a few years ago. LULU will win if it can differentiate itself through brand. It will lose if it cannot. In any case, kudos to the firm for creating a new segment of retail clothing.