LULU | Aggressive Guide Leaves Little Room For Error

We’re struggling with what to do with LULU on this print. On one hand, the company beat the quarter, driven entirely by top line (Gross Margin down 300bps due to discounting), putting up $4.40 vs the Street at $4.26. We think that turn of events was widely telegraphed by strong credit card data, which is why the stock ripped into the print. But what we weren’t expecting was for the company to issue guidance for 1Q and 2023 meaningfully above the consensus. That’s where we have a tougher time with this one. Inventories corrected to a degree, settling in at ~50% above last year (were +85% at the end of last quarter) – hence Gross Margins down 300bps. (note, it didn’t make as much progress as Nike). But the company’s guide is calling for Gross Margins to be UP 290-320bps in 1Q and 140-160bps for the year. Should sales be robust? Yes. The company’s got the inventory to back it up. But we struggle with how it manages a full price selling model (which it claims it will have) when we’re facing the toughest three-year stack consumer spending comps in the past 12 years in April and May, AND it’s sitting on too much inventory. Granted, the quarter is 2/3 over, so it has decent visibility. But it’s the next 60 days that particularly concerns us. We also are very hesitant to buy into the narrative that freight will be a tailwind this year. Maybe it’s no longer a headwind, but all it takes is one competitor to ‘pass through’ the freight savings in price, and LULU’s business will slow unless it competes on price. In fact, we just saw AtHome announce last week that it’s cutting price on thousands of items as it passes through lower freight costs to consumers to accelerate market share gains (and hasten BBBY’s demise). Different sector of retail, I know, but we fear that the competitive pricing dynamics may be similar. This name sits near the bottom of our short bias list, and that bias is wrong today based on the stock ripping after hours on this guide. If we put our bull hat on, with China recovery (15% of stores but only 8% of revenue base), full priced sell through of the company’s inventory, freight flow through, and FX benefit, we can build to $12.50 in EPS this year. That compares to $11.61 at the midpoint of the guide. That could easily take this stock past $400.  We like this model long-term, and want to buy it at a price. But not with such an aggressive guide when we’re looking down the barrel of one of the toughest consumer environments since the GFC. We’re not going to cover on this event, and will let the dust settle here. We’ll see where the consensus estimates come out, will hone our model, and see if there’s a meaningful variance. Over a TAIL duration, we could get to a $600 stock here, which is why this was never (and likely never will be) a Best Idea Short. The brand is simply too good, too dominant, and has outsized growth outside of North America. Do we think footwear is a mistake? Yes. Was Mirror a massive Black Eye? Yes (wrote off $410 million of the $500mm purchase price this quarter). We think we’re looking at an ‘A’ brand with a ‘B-‘ management team. But still, the long-term growth is there. We simply need to get more comfortable that there’s not a guide-down to come in May/June in the face of a euphoric stock reaction to what seems to be a guide that leaves very little room for error (or Quad4) particularly over the next 1-2 quarters. I know that’s short-sighted in the face of what we think is real long-term upside. But we have to play the cards we’re dealt. And for now, our contention is that they’ll be a shot to buy LULU at a better price.  Stay tuned for more on our positioning on this one…