We’re going Long LULU. Simply put, the longer-term risk factors we’ve been concerned about over time are materially diminished – if not gone. This is one of those unique stories where the TREND factors are completely side-stepping the malaise of its ‘space’, while the TAIL factors have definitely improved on the margin. And to boot, if current management mis-steps – like, even a little – there’s a strong case to be made for very significant management change in March 2018. With no management change, we're likely looking at $3.00-3.25 in EPS power over the next 18 months. With a management swap (ie Glenn Murphy inserting Stefan Larsson as CEO), then there’ll be one of those ‘take down numbers to invest in order to add another $2bn in revenue’ stories – with $4+ in EPS power. Even if current management executes, this change is still on the table.
Upside/Downside Clearly Bullish
Keep in mind that this company has earned between $1.85 and $2.15 for the past five years. It’s finally breaking out of the ‘zero-growth $2 in perpetuity at a 20-25x PE’ thing. If we’re right on $2.87 next year ($0.16 beat) then we’re looking at 20% earnings growth for a premier brand with global growth and a stellar balance sheet – a definite #retail5.0 survivor. Perfectly fair to give that 25-30x, or ≈ $85 in 1-year and $100 in year 2.
If I’m wrong, then I think a realistic worst case is a flat FY18 at about $2.40. While some might argue a re-valuation to a mid-teens multiple on yet another #fail, I’m pretty sure that we’d see major change at the top of the management food chain – which I’d argue will seriously crimp a short case built on a trough multiple on 'meh' earnings. Perhaps we see 18x a $2.40 number – that would not be fun. It’d be miserable, actually. But would also be very short lived with a new management team.
We’ve been in and out of LULU over the years, but always with a net bearish TAIL call on revs and margins given saturation in every key MSA, eroding store economics, growth into lower-return areas, and an inferior management team chasing margin instead of top line. All but one of these factors has changed/improved or has been flat out eliminated. Here’s where we’ve seen change on the margin…
- Men’s. Was a really bad, unprofitable and return-dilutive idea – until it evolved into one of the brand's best business drivers. At $400mm in revenue, it passed the ‘too small to make money’ hurdle rate, while it has taken price points higher on accelerating unit sales. That’s rare, and it’s working. LULU men’s business is like a version of UnderArmour Men’s – but one that consumers actually will buy 20-30% more of each year.
- Int’l. This was another bad idea – but it’s definitely getting less bad. LULU has been spending at a similar rate as UnderArmour in Western Europe and Asia – very return dilutive given the scale needed to actually earn one red cent/euro. The difference between these otherwise similar business models is that UA can gain relevance in Europe through pretty much one sport – football. Nike and Adidas have 90% of that market locked up stone-cold. LULU doesn’t face the same barriers, and the brand has been accepted in Western Europe, now it needs to simply scale (>$175mm w 50+ stores). It’s still return-dilutive, but our concern was that LULU was throwing good money after bad. It’s not. It might prove to be return-accretive within 1-2 years.
- Ivivva. Making yoga pants at a 30% lower price point for 12-year old girls that aspire to look like a teenager was simply not a good idea and was a complete waste of capital. To management’s credit, Ivivva’s store base is shuttered.
- Wholesale model. I’ve beat this company up for years for not having a wholesale model. The company was too focused on controlling 100% of its final sale without tiering product by consumer, by price, and by channel. I was firm on that. I was also VERY wrong on that. What seemed like a flawed strategy three years ago has left LULU reasonably immune to the store closures in the athletic specialty channel – and has offered up better real estate economics in the interim.
- ‘Inappropriately sized Management’. It’s easy to say ‘this is a bad management team’. That’s kind of an arrogant statement. I think management is good, but for an early stage brand navigating through puberty. Unfortunately, LULU is a full-blown hormone-filled teenager. We need a serious management upgrade. Since Glenn Murphy stepped into Chairman role at LULU on 4/7, the likelihood of this happening has never been greater. Ideally, I’d like to see Stefan Larsson (CEO stud fired by Ralph Lauren -- was Murphy’s ‘Golden Boy’ at GPS. Non-compete is up in May).
When I decided on this position change, I was pretty darn sure that this was going out as a Best Idea Long. Then my team and I debated, and the fact is that we’re modeling an in-line back half, and then accelerating growth bifurcation vs the Street’s estimates into 1Q18. Could there be a day before year-end when ‘the credit card data looks bad’ and a 24x PE stock trades off bc all of a sudden bc we might see a penny miss? Yes. We might have a little time on this. And I stress ‘might’.
If it’s a sloppy EPS number – which I’m not expecting – and the stock trades off, then I’ll likely up it to Best Idea – second only to COH (Tapestry – I still can’t get over that name). Or if it’s an in-line print and I maintain my confidence in the growth algorithm – then I’ll do the same, even if it’s at a higher price. If you’re reading this, you probably know my shtick is not trying to call a magic multiple around a quarterly print. But from a risk-management perspective, I’m leaving the ‘Best Idea’ bullet in the chamber. 
