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LULU = Activist Candy

Takeaway: Things are getting so bad that it’s good. If no one goes activist, we might. Shareholders deserve it. Still solid acquisition candidate.

Conclusion: We think that things are getting so bad, that it’s almost good. This company is in worse shape than the quarter suggests. The good news is that every problem we see can be fixed with the right talent steering the ship. The bad news is that such talent is nowhere to be found in Vancouver. The reality is that someone will have to step up and go all activist on LULU. Valuation is at a point where we could see that happening, which could be facilitated by recent tension at the Board level.  And if it doesn’t happen, we might just lead the charge ourselves. Value needs to be unlocked. This is an amazing brand with solid global growth prospects. Management is too focused on recapturing Gross Margin that is a) lost forever, and b) something that investors won’t pay for without meaningful top line growth. If all else fails, there are no fewer than five public companies eyeing LULU, not to mention financial buyers.  

 

DETAILS

We said that the risk/reward for LULU would really shape up on a miss. We’re standing behind that statement. If we had to be long or short at this point, we’d be long. Fortunately, we don’t have to be either. But let’s make one thing abundantly clear. Our view that it is a more favorable risk/reward is not because we have confidence in management executing a sound growth strategy. Quite the opposite, actually. This is as close to a ‘no confidence’ vote as we’ve come across with a management team in a long time. If this was a weak brand with questionable growth prospects, then it’d be game over. But the fact is, this is what we’d consider one of only a small handful of truly defendable brands in retail. When there’s a great brand with bad management, it is a situation that can be easily fixed. When even the greatest of managers are in charge of marginal brands, they’re usually terminal. This is definitely the former.

 

If the play here is for a rebound in the business under the current regime, then it is an absolute coin toss as to whether they succeed. We don’t like flipping coins. Process = Good. Coin Flip = Bad.

 

That means we need major change inside the company.  John Currie (CFO) getting pushed out is a start. He was terrific for LULU in its early years (when Chip was still relevant), and sales were sub $500mm. But so many of us forget just how fast LULU grew, as sales were a mere $275mm in 2007. The skill sets throughout this company today are broadly consistent with those of an entrepreneurial early-cycle company. The problem is that LULU is going through puberty. It is sitting at $1.6bn in sales, and is in need of a completely different range of skills. Unfortunately, we’re not convinced that CEO Laurent Potdevin has them either.

 

WINNING VS LOSING: (LULU should look 948 miles South to see how it’s done)

We think it’s so ironic that LULU reported earnings within 14 hours of Restoration Hardware (RH – our top long idea). Some similarities are striking. Both are $1.6bn in revenue, both serve a very high end consumer in a fragmented and hyper-growth piece of the retail space, and both can conceivably achieve $4-$5bn in revenue over a 5-year time period. The big difference is that the CEO of RH (who many people hate) got on the call, played offense, took control and set the investment narrative. He conveyed top to bottom what his vision is for the company, what it will mean for long-term revenue growth, what the margin implications are, and what kind of capital is needed to achieve those goals and maximize ROI. Laurent said…well…not that.

 

LULU, instead, was extraordinarily defensive. Granted, weak trends will put anyone on defense. But we did not listen to the call and think “hey, these guys really understand their business.” There was no talk about long term growth targets, no crisp delineation of key growth initiatives, with the only real numbers given around share repurchase and gross margin goals.

 

Let’s address the gross margin issue for a minute. The fact that this company leads in with recovery of gross margins to a mid-50s level is preposterous. If the company can recapture a few points in margin over time, then great. But there’s no way we (or most others) will pay up for that now. This is a mid-cycle growth company that is growing outside of an extremely profitable core (dresses, denim, men’s – fine, but not Gross Margin Accretive). There is one thing and one thing only that most investors will pay for with LULU – top line growth.  Yet the only top line growth drivers they really address on the calls are little near-term tactical patches that are irrelevant in the context of investing in Retailers.  

 

THE ULTIMATE PROBLEM

What this means for us, is that the problem is still…you guessed it…Chip (Wilson, Founder). As much as everyone likes to say that Chip stepped away last year, the fact is that the guy still controls 27% of the voting stock. Voting stock aside, his influence inside the hallways of Lululemon trumps that of the CEO that he hand-picked and pushed through the Board approval process. John Currie was Chip’s CFO, and when the Board decided to push him out over the past week, we think that’s what prompted Wilson to vote against the re-election of the two Board members who caused it (one of whom replaced Chip as Chairman).

 

What’s nice about this is that the Board is no longer uniformly ‘Chipped’.  The more the Boardmembers band together and show Chip that he’s no longer the boss, the better chance this company has of succeeding.

 

The reality with all of this is that someone will have to step up and go all activist on LULU. Valuation is at a point where we could see that happening. And if it doesn’t happen, we might just lead the charge ourselves. Value needs to be unlocked.

 

THE ULTIMATE CHANGE: AN OUTRIGHT SALE

One consideration is whether the company’s troubles put it in play. The answer there, we think , is Yes.

  1. Nike is a perennial possibility. Though its strategy is to build instead of buy (and it passed when LULU was at $8) the fact is that it has been chasing LULU for years, and LULU still is far more authentic for Yoga than Nike is. Low probability. But something to consider.
  2. Kering is in print saying that it wants to broaden its portfolio of sports brands (the owner of Gucci also owns Puma, Tretorn and Volcom). Does not hurt that it is a French company and LULU has a French speaking CEO.
  3. VFC is possible. But VFC is rumored to be buying everything. It has Lucy, which is a poor-man’s version of LULU. It’d be interested at the right price.
  4. PVH is an interesting thought. It’s business is in trouble, and what does PVH do when its core weakens? It does a HUGE acquisition. Enter LULU.
  5. Here’s a dark horse…but GPS is not completely out of the realm of possibility. Granted, it’s eating LULU’s lunch with Athleta in markets where the brands overlap. But GPS could handle it financially, and it would give the company some organic growth.

LULU = Activist Candy - LULU financials

 


Poll of the Day Recap: 56% Forecast a 10% Decline in the S&P 500

Takeaway: 56% voted for a 10% decline; 44% voted for a 10% rise.

Although the S&P 500 is down on the day it is still hovering near its all-time highs on essentially no volume, we want to know what you think is next for the S&P 500.

 

Today’s poll asked: What's next for the S&P 500; up 10% or down 10%?

 

Poll of the Day Recap: 56% Forecast a 10% Decline in the S&P 500  - bearvsbull

 

At the time of this post, 56% voted for a 10% decline; 44% voted for a 10% rise.

 

Those who forecast a 10% decline wrote:

  • From here, S&P 500 gain of 10% is about +195.  A gain of that magnitude seems quite unlikely with inflation accelerating, growth slowing, low volume...  However, the caveat is what will the Fed do?  Will the asset purchases taper cease soon?  Will the Fed begin increasing asset purchases again soon after ending the taper?  With greater currency devaluation, it wouldn't be too surprising to see the S&P 500 rise 10% in that monetary scenario.
  • It'll inch up, but not reach the 10% gain before it starts declining; there are too many weak economic factors to consider, and the investors who make the markets move will wise up soon enough..

 

Voters who predict a 10% rise wrote:

  • Despite what seem to be very real and logical macro conditions (for a bear case), emotions and optimism are driving the market for now (and that can't be ignored), so I'd place my bet on 10% up (first), before it eventually goes down.
  • Well at least another 5%  ; if you take the SP/500 range 1993 low to the 2008 high--a 161% Fib extension calls for   from the 1993 low to the 2008 high has 2042 since the 127% 1668 was breached....

 



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Cartoon of the Day: On Your Mark

"Healthcare spending was critical in supporting 1Q GDP. With the census bureau’s release of the 1Q14 QSS survey yesterday, that estimate of healthcare spending saw a sharp negative reversal," wrote Daryl Jones in today's Morning Newsletter.

 

"The net-net of this is that the final estimate of 1Q GDP (June 25th) will be (even more) dismal and GDP is likely to miss the ever bullish consensus expectations for full year 2014."

 

Cartoon of the Day: On Your Mark - On your mark GDP 6.12.2014


@Hedgeye Daily Trading Ranges, Refreshed

Note: The following proprietary buy and sell levels on major markets, commodities and currencies were originally published June 12, 2014 at 08:25. Click here to learn more about Hedgeye CEO Keith McCullough's trading ranges and how you can subscribe.

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BULLISH TRENDS

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BEARISH TRENDS

 

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COGNITIVE DISSONANCE: DEATH BY A THOUSAND DATA POINTS

Takeaway: Domestic growth estimates continue to decline as the data comes in. Retail Sales were soft. Claims were good - but are becoming an outlier.

“Here, our books are filled with numbers. We prefer the stories they tell. More plain. Less open to interpretation”

- Iron Bank of Braavos, Game of Thrones

 

 

After yesterday’s negative revision to 1Q14 GDP (see HOW LOW CAN YOU GO), this morning’s retail sales data should serve as another blow to forward growth expectations. 

 

While full year growth estimates continue to get clipped with regular frequency, the collective cognitive dissonance over the outlook for consumption - in the face of overtly middling data - remains very much entrenched.  

 

Indeed, looking across our Economic Summary table (below), the amount of sequential Worseningcontinues to belie the “accelerating recovery” narrative and sticky, 4%’ish, consensus GDP estimates. 

 

We did see a modest, expected bounce across the breadth of manufacturing/confidence/labor data into 2Q and reported growth will accelerate sequentially but, essentially, we are what the numbers suggest. 

 

Take the average of (soon to be revised lower) 1Q14 gdp and the (overly optimistic) 2Q14 estimate:   

 

(-2.0%  + 3.5%) /2 = More Muddle

 

The current domestic macro reality is that with Inflation accelerating (food, shelter, energy), housing decelerating, the labor market middling, and tougher growth/inflation comps through 3Q14, the intermediate-term trend for consumption growth is one of deceleration.   

 

COGNITIVE DISSONANCE: DEATH BY A THOUSAND DATA POINTS - CPI breadth 061214

 

COGNITIVE DISSONANCE: DEATH BY A THOUSAND DATA POINTS - Eco Table 061214

 

 

RETAIL SALES:  Ugly April figures were revised higher, but back to deceleration in May.

 

Headline retail sales, supported by the significant jump in Auto Sales (+16.7M in May vs. 16.1M April), advanced 0.3% MoM in May (est. +0.6) while April numbers saw a positive revision to +0.5% from 0.1%.

 

Figures were more sanguine under the hood as more than half of industries saw negative MoM growth and decelerating YoY growth.  Further,  MoM growth in the Control Group (which feeds GDP) was slightly negative with growth decelerating -70bps and -10bps sequentially on and YoY and 2Y basis, respectively. 

 

The broader takeaway from today’s data is largely the same as its been the last 6 weeks or so – the numbers are ‘okay’ but do not reflect a material acceleration or any significant rebound demand from deferred 1Q consumption 

 

COGNITIVE DISSONANCE: DEATH BY A THOUSAND DATA POINTS - Retail Sales Control Grp

 

COGNITIVE DISSONANCE: DEATH BY A THOUSAND DATA POINTS - Inventory Sales

 

COGNITIVE DISSONANCE: DEATH BY A THOUSAND DATA POINTS - Retail Sales Table

 

 

INITIAL CLAIMS:  The labor market continues to positively clip along, but it's becoming an outlier amid an avalanche of negative evidence.

 

This morning’s initial jobless claims data showed a moderate, sequential deceleration in the rate of improvement, but the trend remains solid.  The continued strength in the high frequency labor market data is becoming a bit of a positive outlier.

 

Our head of Financials research, Josh Steiner, aptly contextualized this morning’s data:

 

There's growing uncertainty over the macro outlook. Data seemingly in conflict includes labor data that appears to be solid, but housing and retail sales data that are showing signs of cooling off. 

 

Our choice to use initial claims data as our macro weather vane stems from its accuracy in the last cycle at pinpointing both the top and bottom of the cycles on a real time basis. For example, in the last downturn initial claims began to move higher on a seasonally-adjusted basis in late 2007. Recall that the S&P 500 reached its peak level in October, 2007. Conversely, initial claims peaked and began to roll over sharply in March, 2009, also coincident with the trough in the market.

 

With that in mind, this morning's initial jobless claims data is good, though not great. Seasonally adjusted rolling claims are at 315k, which remains in bull market territory by historical standards. Meanwhile, the year-over-year change in rolling non-seasonally adjusted claims came in at -8.8%, also a strong print (though less strong than the week prior).

 

COGNITIVE DISSONANCE: DEATH BY A THOUSAND DATA POINTS - 1 normal

 

COGNITIVE DISSONANCE: DEATH BY A THOUSAND DATA POINTS - 2 normal

 

COGNITIVE DISSONANCE: DEATH BY A THOUSAND DATA POINTS - 16 normal

 

More #InflationAccelerating data on deck for tomorrow…..

 

 

Christian B. Drake

@HedgeyeUSA


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