Krause Fund Research Spring 2021 Consumer Discretionary Lululemon Athletica Inc. (NASDAQ: LULU) Apparel, Accessories & Luxury Goods Analysts April 14, 2021 Daniel Keough Nathan Sheehy Sean Meyer Stock Rating: [email protected] [email protected] [email protected] SELL Investment Thesis Current Price $324 Target Price $280 - $290 We recommend a sell rating for Lululemon Athletica. The increasing industry competition and expected increases in inflation rates all pose a risk to the business. The stock shows a downside of 15%. Company Overview Drivers of Thesis: Founded in 1998, Lululemon Athletica is a Despite forecasting rapid revenue growth and continued Canada-based athletic apparel company that profitability, we believe the company is overvalued because of creates high-quality men’s and women's unchecked growth and excessive market sentiment. technical apparel. With a company focus on The athletic apparel industry is dense with competition. As Lulu yoga, Lululemon creates apparel with a expands from yoga into sports and training, they compete dynamic combination of athletic-wear and directly with companies like Nike and Adidas. leisure. Lululemon now has 521 company- The acquisition of MIRROR will be less profitable once COVID- operated stores in the U.S., Canada, Europe, 19 dissipates and consumers fully return to gyms. Asia, and Australia. Risks of Thesis: Lululemon continues to emphasize market expansion and Snapshot brand awareness. The company experienced 8% growth in North America and 31% growth in international markets. Key Statistics Lululemon’s brand loyalty and rapid immersion into Current Price: $324.00 “athleisure” has been very effective. Many athletic apparel 52 Week High: $399.90 companies are following the trend of combining comfort and 52 Week Low: $199.60 performance, and Lululemon is at the forefront of this trend. Shares Outstanding: 125.1M Market Cap: $43.9B 2020 Revenue: $4,401M 2020 Net Income: 588.9M 12 Month Stock Performance Valuation WACC: 7.92% Beta: 1.34 P/E: 71.6 EPS 2020: 4.52 Ratios ROA: 14.1% ROE: 30.17% Gross Margin: 55.98% 2 Company Analysis Profitability and Expenses Revenue Breakdown As Lululemon continues to grow and solidify themselves as a legitimate competitor in the athletic apparel Lululemon has a revenue composition of three different industry, it is very important to analyze current and segments: company-operated stores, direct to future profitability of the company. Fiscal 2020 halted a consumer, and other. Prior to fiscal 2020, company- streak of increasing net income and earnings per share, operated stores contributed the highest amount of mostly due to the expenses associated with acquiring revenue each year. The pandemic led to Lululemon’s MIRROR as well as a decrease in other income. Below are direct-to-consumer segment, which is sales through the Lululemon’s previous 3 years of basic earnings per share company’s website, contributing the highest amount of as well as our team’s projections for the next 5 years. revenue in 2020. With a growth rate of just over 100% for this segment, it proved to be the reason that Historical/Forecasted EPS Lululemon was able to continue to grow their net 14 revenue. 12 10 8 6 4 2 2018 2019 2020 2021 2022 2023 2024 2025 Although this year had a slight decrease in EPS, we are projecting that the company will be able to increase EPS and net income numbers after fiscal 2021. This increase will be attributed to net revenue growth as well as the Although fiscal 2020 experienced a downturn in company paying the acquisition-related expenses. Lulu’s company-operated stores revenue due to many stores main operating expense components are cost of goods closing temporarily, our team forecasts that this segment sold, SG&A expense, and depreciation and amortization. will be able to successfully bounce back and outperform Our model is projecting all of these numbers to continue direct to consumer revenue in the upcoming fiscal year. to increase as Lululemon’s revenue and business Below is Lululemon’s revenue from the most recent 3 expands in the coming years. years, as well as our team’s forecasts for the next 5 years. Our revenue forecast incorporates historical revenue The Power of Three growth rates excluding 2020, and it accounts for the Lululemon’s management team deploys a strategy of The effect of COVID-19 on each segment. Power of Three, which outlines the company’s plan for growth plans and targets. Product innovation – One of Lululemon’s strengths is their ability to develop products that set themselves apart from this extremely competitive athletic apparel industry. The company uses a “Science of Feel” development platform that allows them to bring in new designs and fabrics to different types of clothing lines. This was also a crucial component to making customers 3 feel comfortable while they worked and exercised from certain periods of time throughout the year. This allowed home. for more customers to be catered to in select markets, as well as introducing new customers to the brand. Omni-Guest Experience – The pandemic significantly altered the way that customers interacted with the Risk Factors Lululemon brand, which resulted in store closures and social distancing requirements. With a decrease in foot Lululemon has numerous risk factors associated with its traffic in stores, the company refined its e-commerce business model. One of these risk factors is that their business and adapted operations in a number of ways. success relies heavily on maintaining the value and They introduced a Buy Online, Pick-up In-Store capability reputation of the Lululemon brand. Much of Lululemon’s which allowed customers to purchase items from their growth and success is attributed to their marketing and website and pick them up in the store or curbside from merchandising efforts. The company utilizes social media their vehicle. Along with this measure, Lululemon for many of its marketing strategies; these can be implemented waitlists so that customers wouldn’t have beneficial, but they can also have adverse effects with to physically wait in line to enter the store with capacity how fast information can be spread. Another risk for constraints. This also led to appointment shopping in- Lululemon is that sales and profitability have the store, where customers could choose times to guarantee possibility to decline due to increasing product costs and them the opportunity to enter the store. To decreasing selling prices. The company experiences a accommodate its focus on direct-to-consumer revenue, cost and pricing pressure due to intense competition, Lululemon invested in IT infrastructure, fulfillment consumers wanting lower prices for items, and changes capacity, and it increased the number of guest educators in consumer demand. Responses to these different risks assisting the Guest Education Center. Lastly, the could have the potential to lower their operating margin company utilized social media channels to interact with if the company isn’t able to offset them with lower customers by offering ambassador-led digital programs, operating costs. Lastly, another significant risk that meditation classes, and other recovery and well-being Lululemon may face is it may be difficult to sustain the tools. rapid growth that the company has experienced since inception. As stated above, Lululemon was founded in Market expansion – Lululemon continues to expand into 1998, and it has grown net revenue from $40.7 million in North American and international markets. In 2020, the 2004 to over $4.4 billion in 2020. Some of the areas that company increased revenue in each operating region; could face potential difficulties with this continued however, 2020 revenue slowed in each region in growth are obtaining sufficient raw materials needed for comparison to 2018 and 2019 revenue as shown below. production, delays in products and shipments, as well as other risks associated with overseas manufacturing. Acquisition of MIRROR In 2020, Lululemon made its first acquisition by purchasing MIRROR, an in-home fitness company with an interactive workout platform. This acquisition was part of Lulu’s growth plan and it aided in driving business through their omni-guest experience. MIRROR generates revenue from the sale of in-home fitness equipment as well as the associated content subscriptions. Many of the Lululemon was also able to expand their seasonal store financial metrics for MIRROR are not fully realized yet, strategy with over 100 seasonal stores in operation for but it did contribute to the increase in net revenue for 4 the fiscal year. Lululemon recognized the costs Market Capitalization, index Dec 2019 = 100 associated with the acquisition, such as compensation, digital marketing, as well as an increase in intangible assets and goodwill. MIRROR is in direct competition with Peloton, which spends more on marketing each year than MIRROR generates in revenue. The acquisition will contribute to a decrease in earnings for a few years to come, but the company is expecting this to be offset by the profits that MIRROR will eventually bring. Lululemon forecasts that the platform could generate Source: McKinsey2 $700 million in revenue and have 600,000 subscribers by the year 2023. Industry Trends & Factors The athletic apparel industry is dense with Industry Analysis competition, and it includes established companies, Industry Description & Overview such as Nike and Adidas, as well as relatively new companies attempting to carve out market share. The apparel, accessories & luxury goods industry is Going forward, we believe there are several trends within the consumer discretionary sector; for the that will differentiate industry winners and losers. purpose of analyzing Lululemon and its peers, our The apparel industry is centered on consumers and industry analysis focuses on companies that rising to meet evolving consumer demands is specialize in athletic apparel. Companies in this crucial. As a result, we believe the most important industry manufacture and sell apparel that is industry-specific trends revolve around shifts in intended for exercise and “life in motion”.