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LULU - 3 Key Questions

Takeaway: When we get our five minutes with LULU's CEO at the company's analyst day on Thursday 4/17, here's what we'll ask.

We’ve been highlighting ‘3 Key Questions’ for CEOs of different companies in retail. The premise is that you have five minutes with the CEO and need to maximize your time by asking only the key critical uncertainties that exist strategically for the company in question. For the most part, the exercise has been theoretical, as not many people will have time with most of these CEOs. But this Wednesday and Thursday, Lululemon will host an analyst meeting in Vancouver, and most people that are interested in the name will have the chance to meet new CEO Laurent Potdevin on his new home turf. When we get our five minutes with him, this is what we’ll ask.


1) Like it or not, you have a lot to prove. It’s easier for most people to doubt you than believe in you. Sorry, but it’s reality. You come from Toms Shoes and Burton Snowboards – two solid brands in their own right – but both are tiny relative to Lululemon, and neither of those brands have any exposure to vertical retail. There were so many eligible executives LULU could have chosen at the time, including several in C-Suites at some of the largest and most successful companies in retail. To your credit, something in you impressed Chip and the Board enough to give you the title shot in running what was a $9bn Enterprise Value (at the time of your appointment). So the questions here are… a) can you shed some light for us on how exhaustive the interview process was (the purpose is to drill down if this was a multi-month courting process, or if it was a matter of weeks – which would be troubling)? Do you have a mandate to transform this company even if it is counter to what Chip wanted? (keeping in mind that he still owns half a billion worth of stock). What can you do for this company that Christine – or a proven CEO of a $3-4bn company cannot? Are there any advantages to not being jaded by having worked for a retailer before?


2) All companies go through different stages of maturation. After each burst of growth, there’s usually some kind of negative margin event as a) sales slow and b) the company properly reinvests in the business to fuel the next burst of top line growth. Some companies manage this better than others. Nike, for example, has had mixed results in this arena (but the end result is always positive) while UnderArmour has proven to avoid margin hiccups due to a steady, methodical and extremely effective investment philosophy all along. With that narrative set, where do you think Lululemon fits in? Clearly, the brand momentum has slowed. There’s nothing wrong with that – it happens to every brand. But we have yet to see a material hit to margins in order to fuel the next leg of growth. We’re not talking a 100bp hit in margins to fuel another $300-400mm in sales. That won’t get you the multiple you want. What’s it going to take to add another $1.5bn in revenue over 3-5 years? And if it amounts to a 500bp hit to margins, are you willing to make that investment? (Wall Street might hate you for a quarter, but it might be the best thing you can do for your brand).  Do you have the Board’s authority to think and act that big?


3) Lululemon is notorious for not discounting its product – which is an envious position to be in for any brand. But that strategy works when a brand is $500mm, but not when competition is exploding (Nike, UnderArmour, Athleta, Betty, H&M, VS, Prana, Ideology, etc…), and the sales line is topping $1.5bn. To boot, now the brand is clearly moving outside of its traditional core into seasonal products – and is even going so far as to test dresses (about as far from the Performance category as you can get). The point here is the business has been inching closer to having to put in place a more comprehensive promotional strategy, but it seems like it might be at the point where it has to be more draconian in its actions. The big question for us is a) what do you think of the narrative we set forth? If we are wrong, then why is that the case? b) if you start discounting more aggressively, do you have the information systems, logistics network and outlet centers to clear excess inventory in a way that is brand appropriate? c) if you agree that you need these things, but do not have them, how much of a capital outlay should it require?

Note: While we think margins need to come down at LULU as the company invests capital and becomes more promotional, we think that it will ultimately be a significant top line driver. There’s an important nuance here, in that if margins come down because of a weak top line, then this multiple is in serious trouble. But if the company deploys capital on the balance sheet and SG&A line in an offensive way to facilitate an appropriate product clearance strategy, then margins might come down, but the top line should balloon. While stocks rarely go up when margins are coming down, we’d argue that this does not matter with the stock in the low $50s. We’d be more concerned about the margin trend if the stock starts with a 7-handle. 


I-gaming revs are growing in AC but way below expectations.  We don’t find that as relevant as poker share.  Here, BYD leads the pack.

  • NJ I-Gaming revenues increased 15% MoM to $11.9 million while I-Poker eked out only a 3% gain
  • The reality was that New Jersey online gaming was never going to move the needle for the publicly traded gaming companies
  • We continue to focus on Poker share as I-Poker is likely the only form of internet gaming to roll out nationally (through interstate or federal legislation).  Poker relies heavily on player liquidity and with New Jersey the most populous state to offer the online game, first mover advantage here is critical.
  • While most of the investment community has downplayed online gaming as a value driver for any of the stocks, BYD’s interest in the market leading Borgata poker effort has us excited as the site’s share grew in March and commands 51% of the volume.


Poll of the Day Recap: Majority Says Geopolitics, Inflation Cause of Rising Oil Prices

Takeaway: At the time of this post, the majority went to 66% saying YES and 34% voting NO.

Poll of the Day Recap: Majority Says Geopolitics, Inflation Cause of Rising Oil Prices - americas oil fuled collapse


The price of crude oil has been volatile. WTI broke out above Hedgeye’s TREND line last week, and it was up again this morning to +6% year-to-date.  

Our question was simple today: Do you see oil prices heading higher the next three months?

At the time of this post, the majority went to 67% saying YES and 33% voting NO.

Voters who said YES largely agreed that it had to do with two things: geopolitics and inflation.

  • “Geopolitics [in terms of] mostly Russia holding the Ukraine hostage until the West backs down. If the EU doesn't back away from Ukraine, Russia will invade. This dance could escalate before there is relief.”
  • “Inflation is accelerating. Oil is the liquid gold; therefore, it's accelerating as well.”
  • “The combination of geopolitics and the upcoming summer driving season will lead to prices trending higher.”
  • “Commodities have been ripping humanity a new one all year.  If global central Keynesian drug overlords want the inflation, they will get it.”

Of the group who voted NO, one person explained, “I don't see consumer demand for gas as particularly high these days. All data points to people driving less, and that's a crucial point ahead of the summer driving season.” Another believed a drop in oil price is the United States’ best weapon against Russia.

This morning Hedgeye CEO Keith McCullough noted that he gets a lot of questions specifically about oil because it was one of the few commodities not going up.  But now, he said, “this move plus Natural Gas up +13% YTD isn’t good. It equals #ConsumerSlowing.”



Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

The Casual Dining Dilemma

We remain cautious on select names in the casual dining sector as we believe sluggish sales trends, decelerating consumer spending and accelerating inflation will continue to pressure margins and, ultimately, stock prices.  This raises the question: does the casual dining industry have pricing power?


We continue to like CAKE, PBPB, BLMN and PNRA on the short side and DRI on the long side in the casual dining space.  We will be publishing brief updates on all of our favorite ideas – both long and short – in the coming days.

Same-Store Sales

Black Box Intelligence reported that same-store sales grew +0.7% in March 2014, a 140 bps sequential improvement from the -0.7% reported in February 2014.  On a two-year basis, sales were positive (+0.6%) for the first time since November 2013.  For 1Q14, same-store sales were down -0.3%, a 20 bps sequential deceleration from the -0.1% reported in 4Q13.  On a two-year basis, same-store sales declined -0.8% in 1Q14.


The Casual Dining Dilemma - sales

Same-Store Traffic

Same-store traffic declined -1.2% in March 2014.  This represents a significant 200 bps sequential improvement from February, but continues to confirm that casual dining traffic is in secular decline.  On a two-year basis, same-store traffic declined -1.6% in March.  For 1Q14, same-store traffic was down -2.2%, a 10 bps sequential improvement from the -2.3% reported in 4Q13.  On a two-year basis, same-store traffic declined -3.0% in 1Q14.


The Casual Dining Dilemma - traffic 

Food Inflation And Limited Pricing Power

Given the secular decline in traffic, the casual dining industry has limited pricing power to protect against food inflation.  With the CRB Foodstuffs Index up +18.6% YTD, we believe the casual dining will experience significant food inflation over the next twelve months, particularly when current contracts expire.  How will the industry manage the pressure?


According to Black Box, the per person average check was up +1.8% in March and up +2.0% in 1Q14.   This is slightly less than the CPI for food away from home, which is running up +2.25% in 2Q14 and significantly higher than the CPI for food at home, which is running up +0.55% in 2Q14.


As we head into the later stages of 2Q14 and into the fall, we expect to see more companies talk about price increases.  We believe raising prices is risky for the industry given the secular decline in traffic and knowing the consumer can find better value at the supermarket.


The Casual Dining Dilemma - rest value spread




Howard Penney

Managing Director


Fred Masotta



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