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.