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Takeaway: It’s critical to delineate between the brand, company and stock for a name like $LULU, which has great returns, but eroding oper metrics.

Conclusion: Let’s remove the emotion and look at the raw math behind one of the most perennially loved names in retail. It’s critical to draw delineation between the Brand, the company and the stock. We'd avoid it.

It’s so easy to like LULU.

But we have to draw a massive delineation between…a) Lululemon the Brand, b) Lululemon Athletica the company, and c) LULU the stock. The first one is great. The second is good. And the third is below-average at best.

The Long term/TAIL, growth is there for this company if it properly allocates capital into fulfilling the Brand opportunity. This is a mere $1.2bn brand (closer to $600-700mm wholesale equivalent in comparing to the NKEs and UAs of the world), and there’s no reason why it can’t get to $3-$4bn over 5-years if it continues to execute. The key here is that if you look at share of the Yoga market, and what those revenue numbers suggest, it implies that LULU will own over 100% of the Yoga space. Clearly that’s not possible. But when you look at great brands in the past, they have continually proved investors wrong by creating new spaces and filling them with product ideas that most folks like you and I cannot even foresee. LULU is one of those companies.

BUT…And it’s a big ‘but’. When we remove all the emotion around the cult stock status it’s been awarded and simply look at the math, we can’t get our hands around the eroding productivity of existing assets.

By all means, we give LULU the credit it deserves for 100%+ returns on capital. But this is by way of churning out 7x+ asset turns on 25%+ EBIT margins. Maybe one of these factors is sustainable. But if LULU sustains both – as it is priced to do – then it will be the first company in recent memory to do so, aside from Apple. Sustaining both would suggest that there is something so special about it that it is massively undervalued even at current levels. So the simple question is really – “Is LULU = AAPL?” As great as it is, we’d give that one a definitive ‘No’.

While we’re believers in the concept and the brand, we can’t make the leap to assume that it can prevent a continued rollover in new store productivity. And in fact, we’re surprised that more attention has not been paid to the issue.

Here’s some geeky math on our thought process around the different between reported comps and the change in total sales/square foot. …

Let’s assume that…

1) total store sales yy chg = (chg in comp store sales growth/square foot + new store sales/square foot) + (yy chg in comp store size + chg in new store size).

2) Therefore yty % chg comp sales = (chg in all stores revenue/sq' - chg in new stores revenue/sq') + (change in all stores size - change in new stores size). Of course, the figures within the parens must be weighted by the number of stores.

3) If store size is basically unchanged then comp growth and the YTY % chg in sales/sq' in comparable stores should be the same.  in other words, comp growth = revenue/sq' growth in comp stores, when store size is unchanged.

4) therefore the difference between reported comp growth in each quarter and the YTY chg in all store sales/sq' in the same quarter will be the YTY % change in sales/sq' at new stores.  Again, in mathematical formula form:

comp stores sales growth - yty chg in all stores revenue/sq' = yty change in new stores revenue/sq' (again weighted by the number of new and comp stores)

5) But backing this number out, yields increasingly negative growth rates in new store revenue/sq', so what are we missing?

Using 1Q12 as an example:

comp growth (GAAP): 24%

YTY chg average sales/sq in all stores: 11%

YTY % chg in average store size: 1%

Residual: 12%

number of non comp stores: 42
number of total stores at qtr end: 180


  11%=(138/180) x 24% + (yty chg in new store revenue/sq' x (42/180))

11%= 18.4% + (.223 x yty chg in new store revenue/sq')
(11%-18.4%)/.223 = yty chg in new store sales/sq'
-31.7% = yty chg in new store sales/sq'

In looking at these numbers on the heels of implied new store productivity going from 175% in 2010, to 95%in 2011, and then down another 30% in 1Q12, we think that we’re going to need to see a massive ramp in comp in order to offset this trend.

Maybe what we’re missing is the impact of dot.com, and the quirky accounting therein. Regardless, we’re going to point back to the simple ROIC calculation. Can the dot.com business grow faster than productivity at existing stores will erode? We’re not so sure. If that’s the case, then either asset turns or margins are coming down. That means that ROIC comes down. That means that a 30x+ p/e multiple matters again.

Will all of this come out with tomorrow’s print? Maybe. Maybe not. But we definitely would not touch the stock in advance of the quarter.The downside if this trend perpetuates is far worse than the upside would be if it reverses.

If I gave Keith the fundamental OK, he’d likely short this stock in a heartbeat.