LULU – More Ways To Win Than Lose

Takeaway: Great category, solid brand, weak company, and a horrendous mgmt team. But in the $30s, we think there are more ways to win than lose.


We like LULU, but it is not for the typical reasons we traditionally look for in a long. We added the name to our best ideas list on June 15 because of our view that things were so pathetically bad at LULU, that it would lead to positive change. Add on what we thought was capitulation by the sell-side (LULU currently has its lowest Buy ratio in history), and very defendable downside in the low-mid $30s due to attractive LBO/acquisition math, we think that this is ripe for a restructuring.  Even most LULU bears would probably admit that this is a very strong brand in a superior category with global appeal – they’ll probably just argue that the competition is too fierce and LULU is ill equipped to face it head-on. We actually agree with that logic. That’s why it needs to be changed radically from what we see today.  Yeah, John Currie is on his way out as CFO – that’s a plus. Also, Chip Wilson sold half his stake to Advent, and we think that the rest of his stake is on the way out.  But, we think the change we’ll see will be a lot bigger than that. The problem is that this is a global mid-cycle growth company approaching $2bn in sales, but it has a management team that is appropriate for a sub-$500mm localized brand.


As for what’s next on the ‘change agenda’, we think that the speed of change depends on the company’s own financial results. If the next couple of quarters pan out as we think – which is not very good – then we think the most probable outcome is that the Board fires Laurent Potdevin – the CEO it hired just 8 months ago. He’s simply not the right guy for the job. Never was, and never will be. He’s only led small brands like Toms and Burton, but he simply does not have the skill set to make LULU a great global brand with efficient operations across multiple distribution channels. Our view is that the only reason the Board approved Laurent is because Chip simultaneously agreed to give up his Chairman title if Potdevin was named CEO. That move left Wilson powerless (no Chair, no CEO, no majority, NO power), which led to him unwinding his stock. It also suggests that the Board is not married to Potdevin, and we think it will make the right call in replacing him if need be. We think that there’s an 80% chance that Potdevin is gone in a year’s time. 


There are a lot of other changes as well beyond human resource management. Other changes should be made regardless of who is at the helm – like developing a competitive pricing process. LULU is the worst company that we’ve seen in many years when it comes to appropriately changing the prices on its product as the selling season progresses. It needs the information systems, potentially physical outlets, and definitely a more sophisticated system to sell aged inventory online and ship directly from stores. And yes, it might even need a wholesale model. These are all decisions that should be vetted by the management team LULU deserves – but does not have.


So basically, if trends weaken further and it is clear that this management team cannot create value and grow this business profitably, then we think we’ll see a completely new executive team put in place to make it happen. Advent did not buy back 14.8% of LULU for $845mm after all these years to passively watch it die on the vine. So in this case, we think Bad News = Good News. If by chance (and we think it would be sheer luck) that this management team gets this engine running, then that’s probably good for the stock as well.  Good News = Good News.


We’re very careful about these ‘things are so bad that it’s good’ calls, because they usually have a way of missing even lowered expectations and destroying value.  But that mattered to us when the stock was near $70, and even earlier this year when it was in the $50s. But with the stock in the high $30s, sentiment worse than it has ever been (EVER is a long time), and value investors increasingly coming out of the woodwork exploring with us what the trough earnings number is for LULU (it’s $1.50, by the way), we’re simply not as concerned at current levels.  Could it trade down on horrible print? Yes, but we think things are bad, not horrible.  In a perverse way, we’d like to see LULU faceplant this quarter. Because we don’t think the equity market would punish it commensurately to the economic impact of the miss itself, but it would be an event that would likely cause the Board to shake things up.  Ultimately, there is $4bn in revenue to be realized here – likely at a high-teens margin. That’s $3-$3.50 in EPS power. At $38, that’s 11.6x earnings, and 7.5x EBITDA. Sounds pretty defendable to us. We just need a team in place that can deliver.


LULU – More Ways To Win Than Lose - lulusentiment1




  • In LULU’s 28 quarters as a public company it has beat estimates 27 times by an average of 16.5%. Over the past 8 quarters the average beat was 7%. There have been pre-announcements and guide downs along the way, especially over the past 12 months, but in general LULU doesn’t miss.
  • Luon Recall was 3/18/13 and Luon was back on shelves 6/4/13 about a month into the 2nd quarter last year
  • Chip comments on Bloomberg fell at the start of the 4th quarter (11/5/13)



  • Internet traffic rank which takes into account organic visits and page views per visit was up 25% relative to all other sites on the internet.
  • Monthly traffic improved sequentially in June and July from trough levels in May and was up 68% in the quarter. A 2000bps improvement sequentially from 1Q14. The improvement could be driven by LULU jamming more inventory through the e-pipe. That could have negative margin implications, or if it does not result in better e-comm sales it could simply mean that the company did a lousy job converting. But the trends initially look decent.

 LULU – More Ways To Win Than Lose - LULU2


LULU – More Ways To Win Than Lose - lulu3


Gross margin – key negative driver here are product margins

  • Over the past 5 quarters (1Q13 -1Q14) product margins have been down by 90bps, 220bps, 220bps, 270bps, and 310 bps respectively. Two year comp in 1Q, -200bps. Management guided margins down another 300bps for the upcoming quarter that would assume product margins down 200bps, 50bps from fx, 30 – 40bps hit from new Ohio DC. Much of deleverage comes from mix away from core to seasonal which has lower IMU due in part to inefficient supply chain and inventory chase.


  • Investments listed below and 14 pop-up shops adding an incremental $10mm in SG&A

Revenue Drivers

Near term stop gap measures intended to drive ‘traffic and sales’. These all seem weak at best. But it’s what LULU has called out.

1) Allocating additional floor space to men’s at store locations in Santa Monica, Vancouver, and Miami

2) London – on track to do in excess of $2,200 per square foot in year one

3) A social media platform focused on Brand Ambassadors

4) In-store tablets allowing guests to shop online inventory

5) Paid search advertisement

6) 14 pop up shops across the US and Canada open from April through September


Long term (these make more sense to us, but only partially address LULU’s problems)

1) Additional 120 stores to be added across North America

2) 40 international stores (20 Europe, 20 Asia) by the end of 2017 in addition to anything added on top of 30 store base in Australia and NZ

3) Go to market calendar – Spring/Fall 2015

4) Rebalance of core and seasonal product – Starts in 2H14 but won’t be fully implemented until 2Q15

5) Revamped product engine – 1Q16


Guidance Considerations

Getting within spitting distance of management guidance for the quarter is not terribly heroic. To get to the mid-point of guidance and in line with consensus for the quarter calling for revenue of $375mm - $380mm and EPS of $0.28-$0.30 we need to assume the following…

1) Revenue growth of 9.6%. Square footage growth of 20% YY, -4.3% consolidated comp (-9% store and +22% DTC).

2) Gross margins down 300bps and flat sequentially from the first quarter on the 2yr trend line

3) SG&A up 25%, implying 440bps of deleverage

4) EBIT margins down 738bps YY.

5) EPS growth of -26%


A little tougher to get to annual guidance. To get to the mid-point of guidance and in line with consensus for the full year calling for revenue of $1.77bil - $1.80bil and EPS in the range of $1.71-$1.76 we need to assume the following…

1) Revenue growth of 12%. Square footage growth of 18%. Flat consolidated comps (-5% store and +24% DTC).

2) Gross margins down 170bps to 51%.

3) SG&A up 24%, implying 300bps of deleverage

4) EBIT margins down 465bps

5) EPS growth = -10%

NICKEL: A Ban on Unprocessed Nickel Ore from the Philippines Looks Several Years Away

Please see the conclusion of this note for recent changes in the expectation of supply-side dynamics in the base metal complex.


Indonesia’s move to ban the exporting of unprocessed minerals in January has undoubtedly helped propel nickel prices +~40% YTD:

  • Indonesia previously the largest exporter of nickel ore
  • Decrease of ~$3Bn in annual exports
  • Indonesia previously accounted for 1/5th of global supply (largest producer)
  • China and Japan were two largest buyers:
    • China consumed 47% of nickel produced globally in 2013

The Indonesian government has no plans to lift its ban of unprocessed nickel ore. Jakarta believes producing, refining, and smelting domestically will be much more lucrative moving forward. Miners have now been forced to develop this capacity:

A report from Indonesia’s Investment Coordinating Board indicates they are in fact investing in the second-leg of the production process:

  • $8Bn spent to build three alumina refineries and two ferronickel projects
  • 102 Nickel Smelters in the process of being constructed

On August 28th we published a note outlining the new exemptions created for the exporting of unprocessed copper bauxite, but Jakarta doesn’t appear willing to move in the same direction for nickel:


Is Indonesia's Export Ban on Copper Bauxite Nearing Resolution?


With the Nickel Ore supply from Indonesia cut-off, both China and Japan were forced to turn elsewhere for raw minerals:


  • Chinese imports of nickel ore from the Philippines have more than tripled since Indonesia’s ban
  • The Philippines is now the LARGEST Nickel Ore supplier to China
  • THE Philippines has supplied 61% of China’s unprocessed nickel ore for pig-iron production YTD; iron ore can also be used
  • Pig iron a common ferrous metal used by the steel and metal casting industries  


On August 27th the Philippine House Natural Resource Committee proposed a bill to ban raw mineral exports following Indonesia’s move in January. The logic for the proposal echoes Jakarta’s reasoning in that building the infrastructure for the domestic capacity for the second-leg of the production process is a more lucrative venture than just exporting the raw mineral itself.


Congressman Erlpe John Amante estimated Indonesia’s revenue from exports would triple if miners were forced to refine the raw minerals (implement this second stage of the production process).  


The speculation fueled heavy buying late last week:


Thursday (09/04): +2.85%

Friday (09/05):    +1.67% on volumes +34/51/46% above 1/3/6-month averages

Monday (09/08): +92bps on volumes +26/39/34% above 1/3/6-month averages


The market pulled back significantly late in the day London time after a statement from Jakarta (-4.9% in late trading):

  • Philippine congressman Erlpe John Amante stated today that a mineral ban may not actually be in place for an estimated 7 years
  • 2 years before proposed bill is put into law
  • 5 Year reasonable grace period for miners to adapt




  • Indonesia moved to pass the bill in 2009 which gave the government the POWER to implement the ban which
  • Most miners wrongfully assumed the bill would not be signed into law
  • The move in January forced the necessary cap-ex and infrastructure spending. As mentioned above, this is now happening with the 102 Nickel smelters now being developed across Indonesia




1)      QUANT: The quant set-up is the most bullish of all commodities in TACRM, and we will continue to manage the risk of the range with a bullish intermediate-term TREND bias on the China catalyst.


2)      LONG-TERM: Late cycle cap-ex spend from miners will continue bringing an increasing supply of copper, nickel, and iron ore that will have to be met with a sustained increase in demand (China in particular).




  • The implementation of a nickel ore export ban from the Philippine government appears less threatening on the margin over the next several years
  • Chinese coal imports hit 18-month low in August (China consumes 1/4th of coal globally)
  • Chinese iron ore Imports from Port Hedland, Australia reach a record 32M tons in August in as BHP and Rio Tinto increasing production
  • Indonesia lifts the ban of unprocessed copper ore bauxite:
    • A shipment of 10,000 tons of copper concentrate left Indonesia for China on Aug. 8
    • Meanwhile more of a push elsewhere to diversify supply lines:
      • China’s MMG closed on a $7Bn acquisition of the Las Bambas copper project in Peru in July
      • Chinese backers are now behind one-third of all Peru’s new mining investments by value

 Please feel free to ping us with questions or additional color. 


  NICKEL: A Ban on Unprocessed Nickel Ore from the Philippines Looks Several Years Away - TACRM Table



Ben Ryan



Supply Side Stagnation: A Few Quick Charts

Takeaway: Decline in NFIB Hiring agrees w/ the sequential deceleration in the NFP and ADP data in Aug. Measures of labor slack continue to tighten.

We discussed the burgeoning divergence between actual consumption and capacity for consumption yesterday  >> FIVE-FECTA: CONSUMER CREDIT GROWTH ACCELERATES (AGAIN) IN JULY


Today’s small business confidence and labor turnover data reflected sequential deceleration in employment, agreeing with the sequential declines reported in the ADP and NFP releases for August.  


Meanwhile, measures of labor slack continue to point toward ongoing, albeit slow, tightening in labor market conditions – lending some incremental support to the emergent view of supply-side barriers to hurdling secular stagnation.      


NFIB/EmploymentHeadline Small Business Confidence increased for a second consecutive month, rising +0.4pts in August.  Job Openings and Outlook for General Business Conditions led the upside but Hiring Plans and Sales Expectations dropped -3 and -4 pts, respectively. 


Private payroll growth continues to run ~2%+, which matches peak growth in the last cycle and may be as good as it gets given the demographic and labor supply headwinds and the secular slowdown in employment growth over the last 30 years.


Supply Side Stagnation: A Few Quick Charts - NFIB Hiring plans Aug


Supply Side Stagnation: A Few Quick Charts - NFP Private YoY 090914


Supply Side Stagnation: A Few Quick Charts - NFIB Table



(Declining) SLACK:  Both the Jobs Hard to Fill and the Compensation Indices rose to new cycle highs in August (NFIB data) while Total Job Openings, Total Hires, and Quits moderated sequentially but held at 13 year highs in July (JOLTS data). 


Further, the share of short-term unemployed continued to rise in August while labor supply (total available workers per job opening) remains just north of pre-recession averages. 


In short, while signs of moderate sectoral shift and employment hysteresis remain, the labor market remains moderately tighter than the FED officialdom gives lip service to. 


Whether the acceleration in hourly earnings for nonsupervisory and production employees to a 4-year high of  +2.5% in August is evidence of that tightening being passed through in the form of accelerating wage inflation remains TBD.   


Supply Side Stagnation: A Few Quick Charts - NFIB compensation Aug


Supply Side Stagnation: A Few Quick Charts - NFIB Hard to Fill Aug


Supply Side Stagnation: A Few Quick Charts - Short term unemployment    of Total


Supply Side Stagnation: A Few Quick Charts - Jobs per available worker



Cycle Accounting:  Historically, over the last half century, initial claims and peak monthly NFP gains have led the peak in equities and the peak in the economic cycle by 3 months and 7 months, respectively.   


Whether the recent trough in claims in early August or the Apr-June NFP gains represented peak improvement in those measures remains to be seen, but it’s worth monitoring given the fairly consistent temporal sequence in the labor --> equity market --> economy over the last half century.  


Supply Side Stagnation: A Few Quick Charts - Initial Claims Months from Trough


Supply Side Stagnation: A Few Quick Charts - Laobr cycle half table



Christian B. Drake



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Off the Radar: Yet Another Example of the Hyper-Inflated Market Bubble

Takeaway: It's all fun and games and pink fluffy unicorns until the music stops.

In the latest sign of our hyper-valued, bubbly marketplace, we give you EBates...

Off the Radar: Yet Another Example of the Hyper-Inflated Market Bubble - fr3


Rakuten to Buy Ebates in Japan’s Biggest E-Commerce Deal


  • "Rakuten Inc. agreed to buy U.S. rebates website Ebates Inc. in Japan’s largest e-commerce deal as the operator of the country’s biggest online mall seeks overseas growth through acquisitions."
  • "Rakuten will pay $1 billion in cash for all of Ebates, it said in a filing to the Tokyo Stock Exchange today. San Francisco-based Ebates offers cash rebates to customers who buy products ranging from laptops to lipsticks from the website’s retail partners."
  • "Rakuten’s billionaire chairman Hiroshi Mikitani is betting the purchase will help the Tokyo-based company push its global e-commerce strategy. Rakuten has also been plowing cash into technologies such as mobile applications and online video as it seeks to add to its online marketplace business."


There are no direct public company implications here. But the simple fact that a Japanese company is buying an early cycle, non-asset-based US e-tail startup for $1bn in cash is pretty much huge any way we slice it.


In order of magnitude, this is like when Amazon bought Zappos for $928mm six years ago -- near the top of the last cycle.  Except for the fact that Zappos actually had a brand... And a loyal customer base... And warehouses... And suppliers... And revenue...  

Why Vladimir Putin Is More ‘Judo Master’ Than Chess Player

“Vladimir Putin firmly believes that martial arts teach such knowledge, abilities and skills that every politician needs. Putin believes that judo trains both your body and your mind. It develops strength, reaction, endurance, teaches self-control, the ability to feel the moment, to see the opponent’s strengths and weaknesses, to strive for the best results and constantly work on improving oneself.”

- From the Kremlin’s website on Putin’s “Interests”


It’s no secret to any student of Russian President Vladimir Putin. The man loves Judo.


Putin started practicing Judo when he was 11 years old and Nikita Khrushchev was still at the top of the Soviet totem pole. He holds a black belt in the sport, is an honorary president of the European Judo Union and has even written a book on the subject, “Judo: History, Theory, Practice.” Last year he was ceremoniously awarded a ninth “Dan” (out of 10) in Taekwondo (for comparison’s sake, that’s higher than Chuck Norris’ eight Dan achievement), and recently attended the World Judo Championship in the southern Urals to view the Russian men’s team take second place to Japan.

Why Vladimir Putin Is More ‘Judo Master’ Than Chess Player - 1. putin


Oftentimes, when commentators try to size up state actors and their influence on geopolitics, the discussion quickly turns to the metaphor of a “chess game” – and the current Russia vs. Ukraine (and the West) conflict appears no different (witness this week’s cover of The Economist with Putin standing on a giant chessboard).


We think the metaphor of a chess match misses the mark in Putin’s case.  We think the metaphor of a Judo fighter is more apt in capturing the essence and approach of Putin since he joined the KGB in 1975.


Moreover, like any great Judo competitor, we fully expect Putin to continue to play to his strength by exploiting Europe’s reliance on Russian oil and gas and leveraging his popular support and Cult of Personality he’s built at home. 


As news headlines fly back and forth on talks of cease fires and additional sanctions between Russia, Ukraine, and the West, we fully expect Putin’s focus to remain squarely on Ukraine, THE key region where he derives strategic influence over the West. We further expect his meddling to continue roiling global markets throughout the year (Note: on a year-to-date basis the Russian equity market RTSI is far and away the worst performing major global equity market, down nearly -14%).


Gaming Influence


If there ever were a “grand” strategy vis-à-vis Ukraine, it has greatly morphed over recent months: Russia lost its Ukrainian puppet leader in Victor Yanukovych and Western sentiment towards Russia dramatically shifted after it annexed Crimea and participated (directly or indirectly depending on who you talk to) in the downing of the private airliner MH17 over Ukrainian territory.


Like a Judo fighter, Putin has the ability to pick his spots of attack. Advantageously, he has the luxury to take a defensive posture (let the opponent strike first) given his strong hand (energy assets).  Meanwhile, despite being compared to Hitler by British Prime Minister David Cameron, or claims that he’s is under the influence of Satan by an Orthodox Church official in Kiev this week, as Adam Gopnik writes in a New Yorker article titled Crimea and the Hysteria of History (March 7, 2014), Putin may in fact be behaving quite rationally as far as Russian history is concerned:  


“Russia, as ugly, provocative, and deserving of condemnation as its acts may be, seems to be behaving as Russia has always behaved, even long before the Bolsheviks arrived. Indeed, Russia is behaving as every regional power in the history of human regions has always behaved, maximizing its influence over its neighbors—in this case, a neighbor with a large chunk of its ethnic countrymen.”


Deriving Advantage


Since his early days in office, Putin has proactively cultivated a macho Cult of Personality, flexing his strength at home and abroad.   Look no further than the widely-circulated press photos of him shirtless on a horse in the wilderness some years back (see photo below) to more recent videos of Putin “scoring goals” amongst former and current professional hockey players. Putin has created a bravado and brawn which serves to throw off and intimidate opponents while also increasing his appeal at home. 

Why Vladimir Putin Is More ‘Judo Master’ Than Chess Player - 2. putin


Fresh off the pride of hosting the Olympic games in Sochi and the “success” of annexing Crimea, Putin’s popular support is now riding at all time highs. According to a Pew Poll, it stands at 83%! 

Why Vladimir Putin Is More ‘Judo Master’ Than Chess Player - 3. putin


Digging in deeper, Putin has been able to maintain high popular appeal throughout his time in office – and this despite popular uprisings that have toppled and challenged authoritarian regimes throughout North Africa and the Middle East over recent years.  


What’s been Putin’s edge to command such support and prevent uprisings at home?  As The New Yorker’s David Remnick, a long student of all things Russia, explains in a Letter From Moscow: Watching The Eclipse in The New Yorker (August 8 & 11, 2014):


“…Putin was able to do what Yeltsin had not: he won enormous popular support by paying salaries and pensions, eliminating budget deficits, and creating a growing urban middle class. It was hardly a secret that Putin also created his own oligarchy, with old Leningrad pals and colleagues from the security forces now running, and robbing, the state’s vast energy enterprises. This almost unimaginably corrupt set of arrangements, which came to be known as Kremlin, Inc., outraged nearly everyone, but the relative atmosphere of stability, in which tens of millions of Russians enjoyed a sense of economic well-being and private liberty, provided Putin with a kind of authoritarian legitimacy.”


Indeed, yet the risk appears in the ability to disguise a “sense of economic well-being and private liberty.”


Resource Legitimacy


Critically, Putin’s authoritarian legitimacy could not be solidified without the country’s resource legitimacy.  In what’s known as “Dutch Disease,” the country has relied squarely on its natural resources for economic growth at the expense of developing and diversifying the economy. Will this come home to roost?  Like any cycle, Russia may be able to disguise its decline over the medium term, but over the longer term—especially should oil prices abate—things get much more troublesome.   


Russia’s energy leverage over Europe clearly remains significant. The share of Russian gas as a percentage of EU imports has grown from 22% in 2010 to over 30% today. The Economist estimates that 50% of all gas that flows to the EU passes through Ukraine. For a refresher on demand at the country level, the NYTimes offers an illustrative graphic (see below):

Why Vladimir Putin Is More ‘Judo Master’ Than Chess Player - 4. putin


While the EU has made developments since periodic suspensions to Ukrainian gas delivery in 2006 and 2009 (for failure to pay incurred debts), they’ve not been significant enough to offset a Russian shutdown. As the chart shows, not only does the eastern bloc (highest = Estonia, Latvia, and Lithuania) have the majority of its consumption tied to Russia, but Netherlands has a 34% exposure, Germany 30%, and Italy 28%. No small potatoes.


Estimates suggest that if Russia were to shut-off supply lines through Ukraine (still a seemingly unlikely scenario though a greater leverage point as we move deeper into the colder months), the EU could survive for an estimated three months with current reserves. We call that significant leverage!


In addition, and as my commodity-focused colleague Ben Ryan points out:  Europe’s ability to source oil and gas is both limited and much more expensive than Russian-sourced energy. For example, LNG that Germany purchases in the international market is about double what it costs when sourced from Russia. Tack on that there is virtually no capacity from the U.S. shale oil boom to help Europe in the immediate, or even intermediate term, and the U.S. has no LNG export facilities.


Finally, Putin has an additional competitive advantage in the recent completion of the Nord Stream pipeline that transfers LNG from Vyborg (near St. Petersburg) up through Finland, and across the Baltic Sea to Germany. In essence, Russia could cut off all supply to Ukraine and not completely isolate the largest European countries.


Playing To Strengths


Despite all the trade sanctions that both Russia and the West may throw at each other, could analyzing the geopolitical posturing be as simple as this? – Russia, while playing with a weak economic hand, can hold on to its energy rich leverage, and simply, like a Judo competitor, wait for the West to move before countering? 


We think it’s that simple.


For us, the promise of Russia intimately mingling with Ukraine for the foreseeable future is high – especially as we move into colder months when heating oil becomes a human necessity.   Jigoro Kano, the founder of modern Judo in 1882, outlined the central principles of the sport:  seiryoku zen’yō or maximum efficiency, minimum effort.  Is this not Putin’s game plan? 


Last week we got a taste of Putin’s tactics:  as the West cautiously hailed Ukraine’s announcement that they agreed to a truce (cease fire) with Russia, Putin allowed the story to gather steam for a bit. Then he commented:  well, Russia is not a party to the conflict, so actually Russia can’t be part of a Truce… , or something to that effect.   In other words, the West gets tripped on itself, while Putin exerts minimum effort to receive considerable results.


That’s Judo.


Matthew Hedrick







Cartoon of the Day: Bubble Bath

Takeaway: Yes, it's a bubble.

Cartoon of the Day: Bubble Bath - bubble cartoon 09.09.2014