LULU | Black Book – Vetting the Growth Algorithm

Takeaway: On Monday, April 11th at 11:00 am EDT we’re hosting a Black Book Call on LULU.

Watch a replay below.

 

Our thesis as it stands today reads like this. We think that this is a very good brand housed within a bad company. Management is shooting to get back to a low-50s gross margin, which is admirable. But the company has to invest in talent, distribution, branding, international and e-commerce capability in order to support a $4bn global sales target. All of which will a) understate the gross margin recapture over the near term, B) subsequently repair the top line (in 2+ years), and then, and only then will we even think about paying for a 'margin improvement story' here -- especially with UnderArmour and Nike committing incremental capital to women's fitness. 

 

With the stock up 30% YTD and 10% over the past two trading sessions, valuation seems stretched. Especially when we consider the fact that the majority of the near term earnings growth is centered on operational excellence (something LULU has never proven it can uphold). On the top line, 2015 was a win for LULU against a set of extremely easy compares in 2014. But, as we look out over the next 1, 2, and 3 years we need to make some bold assumptions to believe that LULU can grow organically in its core market without the benefit of accretive square footage growth, and improve operating margins as it fights tooth and nail for market share.

 

A brief preview of the topics we will be discussing on the call…

1) Long Term Plan – We’ll vet through the long term growth algorithm for LULU which management laid out on its call on Wednesday 3/30. The basics call for $4bil in sales and double the earnings in power. But, if we put all the pieces together: $4bil in sales, low 50’s gross margin, low 20’s operating margin, on a 2% and change buyback, that adds up to $5+ in earnings power. Our analysis will show that requires some very bullish assumptions for a brand that is on the wrong side of the maturity curve in its core market.

2) International – To get to $1bn by 2020 – we need to assume 30% comps for the next 5 years, and more importantly a meaningful inflection in profitability from a business that is currently dilutive. That comes in a region where a) LULU has limited brand awareness and b) is much more difficult to scale profitability due to the geographic limitations and undeveloped global supply chain.

3) Men’s – LULU’s men’s business has been knocking the cover off the ball for the better part of 3 years – with 20%+ comps in each of the past 10 quarters the men business finished the year at $330mm. That’s the past, from here to get to $1bn we need to assume a 25% 5 year CAGR, which would outpace even UA who added an incremental $625mm in its men’s apparel business from '06-'11. That type of growth (we will drill down if we think it’s even possible) we’ll require a significant capital investment to a) build brand awareness and b) reformat stores to give the men’s product a more prominent in store position.

4) E-commerce – 30% e-commerce penetration or $1.2bn in sales doesn’t seem like a stretch to us given the digital sales adoption rate, but the key question that needs to be answered is how cannibalistic is that growth to the in-store business. We can think of a handful of names that have been able to sustain both channels, and maybe half of those which have been able to do it while improving profitability.

5) North America – We’ll dive into each part of the growth algorithm from here, and ultimately flesh out what it means for the top line, profitability, and returns. Each of the three branches in the region is at a very different part of the growth cycle. Canada – mature, LSD comps, no sq. ft. growth. US – saturated in key markets, sq. ft. growth coming from less profitable avenues (bigger stores, less productive regions). Ivivva – sq. ft. and comp growth, but lower margin profile.

 

Call details will be provided prior to the call.