While not outright bullish on LULU, we came away from the print tempering the negative bias we had in prior quarters about trends in new store productivity. New store productivity is still hardly knocking the cover off the ball at a sub-50% level. But it stopped getting worse, and we think that the acceleration in the International story is a clear positive as it relates to perception in hitting LULU’s lofty growth goals over the next 3-years.
The cost of growth is still a concern. In fact, LULU fessed up that higher costs to grow its international presence to buy higher priced real estate will take-down margins from current levels. While we don’t like to see that directionally, let’s face the reality that this is still a sustainably high margin concept with anomalously high asset turns resulting in return on operating assets over 100%. If there’s a trade off between sales and margin it might matter for most companies, but we
think that LULU could sustain this hit without giving up its multiple.
This brand is in a rarified class of great global brands with great growth runway ahead. But like UA, we use ‘global’ loosely with less than 5% of sales currently generated outside of North American borders. That’s about to shift meaningfully and will be a key driver behind ~30% top-line CAGR over the next 3-years. Growth like that is tough to find in retail. At the end of three years, International should be 15% of sales for LULU, slightly ahead of what we previously assumed.
Following favorable tests, LULU is officially moving forward with plans for expansion into both Asia (Hong Kong & Singapore) and Europe (London & Germany) over the next 2-3 years. While this is likely to cost a few points of margin in the process, an investment cycle like this is what can get this brand from $1.4Bn to $3-$4Bn+ over the next 5-years as it continues to develop and create new product opportunities as only LULU can.
One of our concerns on the name recently has been eroding new store productivity trends – that reversed this quarter for the first time in the last six. While positive on the margin, it’s still something to watch closely particularly as the company looks to open larger stores overseas. Larger stores mean higher sales per store, but it’s higher sales per square foot that matters.
It helps that LULU is seeding the market by launching e-commerce and showrooms ahead of stores, but the reality is that even if these stores are targeted for higher density locations it’s simply tougher to squeeze higher productivity out of a bigger box. Given the revenue opportunity associated with this initial investment, we’re willing to give LULU a pass during the early stages as long as we see the incremental revenue growth to justify the effort (and spend).
The setup over the next two quarters – particularly on the top-line – is a tough one for LULU, but international growth should start to hit just as that gets easier next year (Q2/Q3) signaling a significant acceleration in growth over the back-end of what we call ‘intermediate-term’ (2-3 quarters). With $3 in earnings power over the next two years reflecting revenue and EPS growth of 30%+ and 25%+ in 2013 and 2014, we can’t bet against this one here.
Per Keith’s risk management levels, a close above LULU’s immediate-term TRADE level of resistance of $71.34 would suggest a bullish setup near-term.
LULU Risk Management Levels:
LULU SIGMA reflecting return to positive sales/inventory spread: