Lululemon: Waiting For Better Near-Term Visibility

seekingalpha06-14

Lululemon topped estimates in Q1 and increased its EPS guidance for FY24E. Yet, the core North America division posted flattish same-store sales.Near-term concerns seem to be largely attributed to ...

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Yet, the core North America division posted flattish same-store sales.Near-term concerns seem to be largely attributed to ...</p>\n\n<a href=\"https://seekingalpha.com/article/4699231-lululemon-waiting-for-better-near-term-visibility\">Source Link</a>\n\n</div>\n","source":"seekingalpha","html":"<!DOCTYPE html>\n<html>\n<head>\n<meta http-equiv=\"Content-Type\" content=\"text/html; charset=utf-8\" />\n<meta name=\"viewport\" content=\"width=device-width,initial-scale=1.0,minimum-scale=1.0,maximum-scale=1.0,user-scalable=no\"/>\n<meta name=\"format-detection\" content=\"telephone=no,email=no,address=no\" />\n<title>Lululemon: Waiting For Better Near-Term Visibility</title>\n<style type=\"text/css\">\na,abbr,acronym,address,applet,article,aside,audio,b,big,blockquote,body,canvas,caption,center,cite,code,dd,del,details,dfn,div,dl,dt,\nem,embed,fieldset,figcaption,figure,footer,form,h1,h2,h3,h4,h5,h6,header,hgroup,html,i,iframe,img,ins,kbd,label,legend,li,mark,menu,nav,\nobject,ol,output,p,pre,q,ruby,s,samp,section,small,span,strike,strong,sub,summary,sup,table,tbody,td,tfoot,th,thead,time,tr,tt,u,ul,var,video{ font:inherit;margin:0;padding:0;vertical-align:baseline;border:0 }\nbody{ font-size:16px; line-height:1.5; color:#999; background:transparent; }\n.wrapper{ overflow:hidden;word-break:break-all;padding:10px; }\nh1,h2{ font-weight:normal; line-height:1.35; margin-bottom:.6em; }\nh3,h4,h5,h6{ line-height:1.35; margin-bottom:1em; }\nh1{ font-size:24px; }\nh2{ font-size:20px; }\nh3{ font-size:18px; }\nh4{ font-size:16px; }\nh5{ font-size:14px; }\nh6{ font-size:12px; }\np,ul,ol,blockquote,dl,table{ margin:1.2em 0; }\nul,ol{ margin-left:2em; }\nul{ list-style:disc; }\nol{ list-style:decimal; }\nli,li p{ margin:10px 0;}\nimg{ max-width:100%;display:block;margin:0 auto 1em; }\nblockquote{ color:#B5B2B1; border-left:3px solid #aaa; padding:1em; }\nstrong,b{font-weight:bold;}\nem,i{font-style:italic;}\ntable{ width:100%;border-collapse:collapse;border-spacing:1px;margin:1em 0;font-size:.9em; }\nth,td{ padding:5px;text-align:left;border:1px solid #aaa; }\nth{ font-weight:bold;background:#5d5d5d; }\n.symbol-link{font-weight:bold;}\n/* header{ border-bottom:1px solid #494756; } */\n.title{ margin:0 0 8px;line-height:1.3;color:#ddd; }\n.meta {color:#5e5c6d;font-size:13px;margin:0 0 .5em; }\na{text-decoration:none; color:#2a4b87;}\n.meta .head { display: inline-block; overflow: hidden}\n.head .h-thumb { width: 30px; height: 30px; margin: 0; padding: 0; border-radius: 50%; float: left;}\n.head .h-content { margin: 0; padding: 0 0 0 9px; float: left;}\n.head .h-name {font-size: 13px; color: #eee; margin: 0;}\n.head .h-time {font-size: 11px; color: #7E829C; margin: 0;line-height: 11px;}\n.small {font-size: 12.5px; display: inline-block; transform: scale(0.9); -webkit-transform: scale(0.9); transform-origin: left; -webkit-transform-origin: left;}\n.smaller {font-size: 12.5px; display: inline-block; transform: scale(0.8); -webkit-transform: scale(0.8); transform-origin: left; -webkit-transform-origin: left;}\n.bt-text {font-size: 12px;margin: 1.5em 0 0 0}\n.bt-text p {margin: 0}\n</style>\n</head>\n<body>\n<div class=\"wrapper\">\n<header>\n<h2 class=\"title\">\nLululemon: Waiting For Better Near-Term Visibility\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-06-14 16:37 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4699231-lululemon-waiting-for-better-near-term-visibility><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Lululemon topped estimates in Q1 and increased its EPS guidance for FY24E. Yet, the core North America division posted flattish same-store sales.Near-term concerns seem to be largely attributed to ...</p>\n\n<a href=\"https://seekingalpha.com/article/4699231-lululemon-waiting-for-better-near-term-visibility\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"GB00B4QBRK32.GBP","symbol_name":"FUNDSMITH EQUITY \"R\" (GBP) INC","start_time":0,"source_url":"https://seekingalpha.com/article/4699231-lululemon-waiting-for-better-near-term-visibility","article_id":"2443524642","we_media_id":null,"thumbnails":[],"rights":null,"url":"https://stock-news.laohu8.com/highlight/detail?id=2443524642","pubTimestamp":1718354274,"columns":[],"sourceInfo":{"source_id":"seekingalpha","name":"Seeking Alpha"},"weMediaInfo":null,"summary":"Lululemon topped estimates in Q1 and increased its EPS guidance for FY24E. 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Yet, the core North America division posted flattish same-store sales.Near-term concerns seem to be largely attributed to strategic missteps, with Q2 results either confirming or refuting this thesis.Despite shares trading at a discount, the market may remain cautious, waiting for greater conviction that the company can sustain growth in core regions. Until then, a re-rate is unlikely.   Michael M. Santiago/Getty Images News Investment thesis Lululemon (NASDAQ:LULU)(LULU:CA) operates in the athleisure segment, which has been experiencing high growth, largely due to secular trends in wellness. It does so through a unique business model that allows for greater engagement with customers. Notwithstanding market concerns over growth decelerating in its core North America market (same-store sales were flattish YOY in this geography), this seems to be attributed to strategic missteps in the near-term, with management already addressing the issues and indicating continued strong momentum overseas and a robust pipeline of innovation for 2H24E. Despite Lululemon topping estimates in Q1 and increasing the EPS guidance for FY24E, the stock continues to trade at a large discount. Although I think the de-rate may have been excessive, I believe the market will remain on the sidelines, waiting for greater conviction that the company can sustain strong growth in core regions vis-à-vis heightened competition and soft macro. Until then, I don't see any catalyst that would lead to a multiple re-rate. In fact, I think it would be more prudent to wait until Q2 to confirm the thesis that the soft performance in North America in Q1 was a one-off. Lululemon employs a vertical retail strategy Lululemon is a retailer of technical apparel, footwear, and accessories, offering designs for activities such as yoga, running, training, and most other being on the move activities. The company employs a vertical retail strategy, a business model that allows greater connection with customers. The direct-to-consumer (DTC) channel accounts for the majority of sales, with company-owned stores accounting for 46% and e-commerce accounting for 45%. This helps differentiate the brand from competitors as it allows for greater access to consumer behavior data and better position Lululemon to address the needs of customers. Through this process, it can quickly incorporate fashion demand in the design process. Furthermore, the direct connection with consumers helps facilitate communication and engagement. The athleisure market is expected to sustain solid growth The athleisure segment is characterized by a versatile type of sportswear, combining both function and fashion that can be worn daily across sport and non-sport activities. Despite its extensive product assortment, Lululemon is often associated with a brand in the athleisure market. Moreover, the men's line is a key pillar of the company's strategic growth in the future, yet Lululemon's demographics is still largely focused on women (64% of sales), compared to men (23% of sales). The company sees a total addressable market of $650bn, which implies c.1.5% global share as of the end of FY23. As a result, management sees significant growth opportunity in the coming years. In fact, when looking at the expected growth for the athleisure segment in the next seven years, the market expects global growth in the high-single-digits (CAGR24E-30E of +9.3%). This growth should be largely driven by the Asia-Pacific region (+10.3%), with China growing by +10.7%, India (+11.0%), Singapore (+11.0%), South Korea (+11.0%), and Japan (+10.4%). Australia and Europe are expected to grow somewhat in line with the global benchmark (+9.4%/+9.0% versus +9.3%, respectively), with the UK surpassing the growth (+10.0%). North America, though remaining the largest mature market in absolute terms, should gradually lose share to high-growth countries within the Asia-Pacific region (+8.4% versus +10.3%, respectively). In tandem, Lululemon's \"Power of Three x 2\" growth plan aims to quadruple international revenues. Management sees China as a key pillar within the plan, while it expects to grow in core markets (i.e., South Korea, Australia, and UK) and scale in existing/new markets (i.e., Paris, Spain, Japan, and Singapore). Image created by author with data from Mapchart, Grand View Research, Rational Stat, Future Market Insights, and KBV Research  As a result, the company is rapidly expanding the network Lululemon's strategy to expand its network of company-owned stores has been a key driver of top-line performance over the years, with store expansion growing at an average of +15.1% from 2010 to 2023, accounting for c.60% of the top-line (+25.5%) during the period. Moreover, considering that Lululemon is a relatively new brand (founded in 1998), the solid store expansion has also contributed to driving brand awareness, with management commenting this is one of the greatest opportunities going forward. For example, unaided brand awareness in core markets is still low, with Canada at 48%, followed by the US (25%), Australia (19%), UK (15%), and China (7%). Lululemon is a Canadian brand, but its largest market encompasses the US (49% of units), followed by China (17%), and Canada (9%). From 2011 to 2019, most of the store expansion happened in the US, which accounted on average by 57% of all openings during the period. Considering that yoga is a core activity within Lululemon clientele, the rapid growth of yoga/Pilates studios in the US, with a CAGR12-23 of +6.1%, contributed to the strong expansion of Lululemon network in the US (+9.5%). Interestingly, in 2012, Lululemon had 49 fewer stores than Nike in the US, but due to the strong expansion, Lululemon now have +80 stores than Nike. Although it may be argued that Nike and Lululemon focus on different segments of the broader market, it is notable that a relatively new brand already has more stores in the US than the market leader. However, from 2019 onwards, a significant portion of the growth has shifted to China, accounting on average 43% of all openings (versus 22% from 2016 to 2019) compared to an average of 30% in the US. This follows the strategic plan \"Power of Three ×2\", a five-year growth plan launched in 2022 that aims, among other things, to quadruple international presence. By FY26E, China would account for >50% of the international revenue. As a result, China now accounts for 17% of units, compared to 1% in 2016 when the company started opening stores in the country. Image created by author with company data and Investor Day 2022Image created by author with company data, Statista and Yogitimes Image created by author with company data   Untapped potential and business model are driving high returns, likely attracting competition   As mentioned previously, secular trends in wellness are driving global growth in the athleisure segment, which is poised for sustained growth and may continue to outperform other segments within the broader industry. Additionally, having a direct exposure to the DTC channel creates a competitive advantage for Lululemon. The company can better engage with consumers and quickly adapt to consumer demand, which helps drive sales and better margins. For example, comparing Lululemon's business model to those of a peer group of nine companies (Anta (OTCPK:ANPDY), Li Ning (OTCPK:LNNGF), Crocs (CROX), Skechers (SKX), Nike (NKE), Deckers (DECK), Adidas (OTCQX:ADDYY), On Holding (ONON), and Puma (OTCPK:PMMAF)), shows that Lululemon has the highest exposure to the DTC channel (company-stores and e-commerce) at 91% versus 89% for Anta and an average of 42% for the remaining peers. Moreover, given the higher proximity to the end consumer, Lululemon can retain most margin given there's no intermediaries in the transaction. As a result, Lululemon's margin profile ranks high, exhibiting a gross/EBIT margin of 58%/23% versus 52%/13% average for the group, respectively. Furthermore, the direct engagement with consumers has also translated into high levels of store productivity. For instance, comparing the sales per square feet of Lululemon versus peers in the luxury/specialty retail and department stores, shows that the company generated $1,609 per square foot in the latest fiscal year, which is above the $1,000 to $1,200 average range for selected specialty retailers or an average of $250 for selected department stores. Additionally, the contribution of the strong network expansion to top-line is two-fold: (1) it sustains top-line growth due to more units generating sales; and, (2) it sustains same-store sales due to the lower maturity of the network. This is in line with recent comments from management during the last earnings call, where they said that I would say in terms of new store openings, we continue to see opportunity and runway across all of our geographies. In the U.S. specifically, we see sales -- very productive sales per square foot above our average, which is around $1,600 per square foot. We tend to look at new stores as ramping into their full mature volume over a two- to four-year period. I would say we're continuing to see that, and we see ample runway in both the U.S. as well as importantly, our international region. As an exercise, analyzing Lululemon's average top-line growth performance in the last three years, China ranks higher (+49%), followed by the US (+27%) and Rest of the World ((RoW)) (+33%). In tandem, China has the lowest percentage of stores with at least three years across geographies, accounting for 43% of the network versus the US with 86%, and RoW with 70%. Thus, the lower maturity curve of stores in the International division may continue to help sustain same-store sales, given management plans to quadruple international presence by FY26E. Additionally, Lululemon's return on invested capital also screens high among Western peers. Based on the latest fiscal year and including operating leases, the company generated a return of 48% compared to a median of 22% for peers (ex-China) or 29% with the Chinese peers. Moreover, the high return of Lululemon is notable considering its capital intensive business model, driven by the DTC channel (company-owned stores). For example, Lululemon has the highest Capex to sales ratio (7%) among its peers, compared to the group average of 3%. This highlights the success of the direct to consumer strategy and management's ability to convert brand awareness into a profitable business. Image created by author with company dataImage created by author with company dataImage created by author with company data As a result, I believe that the attractiveness of the athleisure segment (growth and profitability), is likely to attract greater competition in the coming years. This dynamic should evolve in terms of product assortment and business model (emphasizing the DTC). For example, Nike plans to increase its presence in the DTC/digital channel as a way to better engage with consumers. Moreover, I view Nike as possessing the capability (i.e., creative team, distribution channels, access to the latest textile technology, etc) to compete in any new segment that it finds interesting. In tandem, other retailers have also expanded to women's athletic apparel, such as The Gap, with the Athleta brand, and Victoria's Secret, with its sports line. Additionally, Alo Yoga, founded in 2007, competes directly with Lululemon and has already generated $1bn in sales in 2022. The company plans to start opening stores in Europe this year while it's CEO mentioned in 2023 that “Next year, we will have over 100 stores companywide. We will be opening one new store every single week.\" In a similar fashion, Vuori, founded in 2014, is also quickly expanding its presence in the athleisure segment, being halfway to opening 100 stores by 2026. The company's strategy also seems to fill whitespaces left by market leaders. It reached a valuation of $4bn in 2021 after receiving $400mn in funding by Softback Investment Advisors and Trinity West Venture. Besides execution, it's worth noting that part of Lululemon's success is driven by its unique business model (emphasis on the DTC), and focus on a high-growth niche segment of the industry. Moreover, although its current growth plan encompasses portfolio expansion into new categories, management has wisely focused first on specific products catering to its core clientele, developing a loyal customer base and avoiding direct competition with larger players within their expertise. For instance, comparing the portfolio mix across peers, Lululemon has the highest exposure to apparel (>70%), while Under Armour (UAA) has the second highest exposure (66%). Consequently, as untapped growth potential decreases and competition stiffens, the growth and profitability profile may change in the future. Image created by author with company data \"Power of Three ×2 plan\" aims to double the business in 5 years In 2019, Lululemon unveiled its five-year growth plan \"Power of Three\", aiming to double men's, double digital, and quadruple international revenues. The company delivered the target results in FY21, two years ahead of the schedule. In 2022, management launched an updated version of the plan, called \"Power of Three x 2\", aiming to repeat the past performance by FY26E. As a result, Lululemon aims to reach total revenues of $12.5bn (versus $6.3bn in 2021), implying a CAGR21-26E of +15%. Notably, this guidance already implies North America decelerating versus the previous five-year cycle. For example, this division delivered a CAGR16-21 of +20%, which is half the implied growth (+10%) in the FY21-FY26E cycle. As a result, market concerns over a deceleration in the US may not be entirely justified as the guidance already implies this trend, while the market also expects growth in the athleisure segment in North America to be somewhat below the global benchmark. Despite lower growth expectations, management's guidance may suggest continued market share gains in the region until FY26E (c.+10.0% versus +8.4%, respectively). In contrast, the International division is likely to become more relevant for top-line performance in the coming years. For instance, the guidance implies revenues growing above +30%, while China will be key to sustain this solid growth as the country must grow ~+40% during the period. Consequently, International and China should account for 31% and 17% of total consolidated revenues by FY26E, respectively, compared to 15% and 7% in FY21. Image created by author with company data China is key, and international e-commerce is expected to increase in relevance As mentioned, management's guidance shows that China is key to achieve the top-line performance into the future. For FY24E, out of the 35 to 40 net new stores, only 5 to 10 stores will be in North America, with the remainder in the International division, primarily in China. The country should account for over half of the International division revenues by FY26E. In terms of channel, the guidance also implies e-commerce gaining relevance within the International division, achieving ~50% by FY26E compared to approximately 30%-40% in FY21. With that, Lululemon's digital strategy is crucial to drive brand awareness and engagement, especially within Chinese consumers, leading to increased on/off-line sales. Our international business remains under-penetrated and continues to represent a significant growth opportunity. For the full year 2023, international was only 21% of our business, and over the long run, I see the potential for it to grow to 50% as we continue to expand our presence outside of North America. Lululemon's strategy in China focus on building local communities and ambassador groups by organizing sports gatherings and workshops. The ambassador groups are usually made up of yoga instructors, influencers, and elite athletes. This strategy is further enhanced with in-store classes, which helps drive better connection with customers and word-of-mouth marketing. Moreover, China's Healthy initiative and high levels of stress among the Chinese population following the pandemic, have contributed to activities that focus on relaxation, hence benefiting core activities (i.e., yoga and pilates) promoted by Lululemon. For example, from 2017 to 2021, yoga studios in China tripled to c.42,000. In tandem, since 2017, there's been an increase in search volume for the keyword \"Lululemon\" in Google trends, with the popularity increasing from roughly 0 to 80-100 currently (maximum is equal to 100). Interestingly, since mid-2021, despite consumer confidence in China showing soft trends, Lululemon's top-line performance has moved in the opposite direction, growing on average by +49% during the period. Moreover, tier 1 and 2 cities drive the popularity of searches, suggesting that Lululemon's strategy to cater to young/urban, and mid to high-income Chinese earners has been successful thus far. Image created by author with company data, Google Trends, and FRED The marketing strategy adopted by Lululemon in China fosters an inclusive environment through a sense of brand community where consumers identify with a particular aspirational image (i.e., while girl aesthetic). Furthermore, the company emphasizes premium products for a niche market. This is in contrast with leading players in the sportswear market (i.e., Nike and Adidas), which are focused on a wider audience. Moreover, by targeting an exclusive segment of the population, Lululemon sets itself apart from local brands Anta and Li Ning, which focus on a wider audience with more affordable pricing. Maia Active, which was acquired by Anta in 2023, is a local brand that competes more closely with Lululemon, yet offers lower pricing. As a result, part of Lululemon's marketing strategy in China focuses on leveraging social media to increase brand awareness and reinforce its premium positioning. Interestingly, there's been an increase in social media platforms in China, allowing brands to segment and better connect with specific audiences. For example, among selected peers in the athleisure/sportswear segments on Instagram, Lululemon ranks third in number of followers with 4.8 million, behind Adidas with 29 million and Nike with 307 million. However, on social media platforms widely used by Lululemon's audience in China, the gap decreases, and the opposite occurs. For example, within the Douyin platform, which is similar to TikTok, Lululemon has 482 thousand followers versus Nike's 1.6 million. Notably, Li Ning and Anta have the most followers (5.4 million and 2.6 million, respectively), likely due to a greater focus on a wider audience in China. Yet, by increasing segmentation, the picture changes. Lululemon has been largely focusing on the Xiaohongshu social platform (aka \"Little Red Book\" or \"Red\"), a fast growing lifestyle platform founded in 2013. The platform focus on specific niches, emphasizing premium brands with a demographic skewed towards Gen-Z females in top-tier cities. Moreover, it allows for live streams by \"Key Opinion Leaders\" (KOLs), who are similar to influencers and perceived by Chinese consumers as more trustworthy. As a result, Lululemon ranks first on this platform with 154 thousand followers, ahead of local brands Anta and Maia Active, and the market leader Nike (141 thousand, 139 thousand, and 135 thousand followers, respectively). Image created by author with data from social media platformsImage created by author with company data, Daxue consulting, and Xiaohongshu  Additionally, when analyzing a global ranking of social media platforms by number of active monthly users (MAU), both Douyin and Red appear on the list, with 755 million and >300 million, respectively, year-to-date. Notably, these platforms are mostly used in China. Moreover, Red was one of the fastest growing platforms in China in 2023, growing the number of monthly active users by +20%. Consequently, I view Lululemon's marketing strategy, leveraging digital platforms, as key in the coming years. This is true as it provides a direct connection with consumers while creating opportunities to both build brand awareness and gain valuable insights into consumer needs in the country. Moreover, this bond also creates competitive advantages, as users usually switch from social media to an e-commerce to place an order. For example, according to Quest Mobile, after an user closes the app Little Red Book, 77.1% of the e-commerce purchase happens on Taobao. Image created by author with data from social media platform, datareportal, WalkTheChat, and Quest Mobile  Q1 came in ahead of consensus, debunking any bear thesis for now Lululemon reported Q1 revenue and EPS that came above consensus estimates (+0.6% and +6%, respectively). For FY24E, the company maintained its revenue guidance of $10.70bn to $10.80bn (+11% to +12% yoy), while increasing its EPS range to $14.27 to $14.47, versus $14.00 to $14.20 prior. Moreover, for Q2, the company expects revenue in the range of $2.40bn to $2.42bn (+9% to +10% yoy), suggesting a step-up in the 2H24E, and an EPS in the range of $2.92 to $2.97. Management also commented that demand for Lululemon's products in the US continues strong So in terms of the U.S., nothing has changed from the last few years into 2023 into the first quarter of this year. The opportunity for us when I look at the business is men's has a number of new innovative launches that are resonating and he's responding very well to. And then in the women's business, traffic, as I mentioned, was positive, engagement in the brand was positive where we had newness. She engaged incredibly well in some of the new innovation we brought. Moreover, management explained that the slow start of the year in the US, which was anticipated in Q4 last year, was largely due to internal factors, including missed opportunities in women's, while the health of the brand remains strong as evidenced by positive traffic in the quarter. Moreover, management stated that When looking at women's, we did not maximize the business in the U.S., which was the result of several missed opportunities, including a color palette and our core assortment, particularly in leggings, that was too narrow. Where we had color, guests responded well, we just needed more as they are looking for additional choices. And we are also out of stock in some of our smaller sizes. And in addition, we saw a fantastic guest response to our newer styles of bags such as the two-tone tote, but did not buy these styles with enough depth to fully capture the demand. Our market share gains were strong in men's in quarter one, and with unaided brand awareness of less than 20% in the U.S., our opportunity to continue to grow this business remains significant. Yet, the company sees these problems as temporary and within their own control, with expectations that much will be addressed in 2H24E. They also provided a positive tone on the back of upcoming product launches and innovation flows scheduled to the mid-to-back half of the year. Elsewhere, in the International division, the company mentioned that the brand remains strong in every market, while experiencing strong momentum in China/RoW, with revenue (in constant currency) up +52%/+30% yoy, respectively. In China, management also emphasized that they continue to see strong trends, and that they have no concerns regarding the competitive landscape. As a result, this explains management's optimism for the remainder of the year, refuting market concerns (at least in the near-term) of softness in its largest geography, North America. Over the last few weeks, sell-side analysts have been debating over whether additional headwinds are underway and whether Lululemon is losing ground as competition intensifies. These also follow the announcement of the recent departure of Lululemon's Chief Product Officer, Sun Choe, with management explaining that the move was largely due to her personal and career goals, rather than the product assortment issue experienced during the quarter. Valuation: LULU shares de-rated after Q4, and continue to trade at a large discount LULU shares are down by -36% YTD (+13% for the S&P500), despite topping estimates in Q1 and maintaining/increasing its guidance for the year. This is also in contrast to historical performance; from 2014 to 2023, LULU shares had an average annual return of +28% versus +11% for the S&P. Moreover, the relative outperformance was largely driven by a period of strong growth (starting in 2018) and margin expansion. For example, from 2018 to 2023, average top-line growth was +24% and average EBIT margin was 20.5%, compared to +13% and 18.6%, respectively, from 2014 to 2017. Image created by author with data from company and Seeking Alpha Moreover, LULU shares now trade at a P/E ratio (LTM) of 25.9X (-37% discount versus historical median or -30% discount versus historical median from 2014 to 2019). The significant de-rate started after 4Q23, when management mentioned a slow start of the year within North America, the most important geography. This raised concerns on management's ability to sustain growth vis-à-vis heightened competition and soft macro. For example, after 4Q23 results, although consensus EPS for 2024E decreased by -1%, the P/E ratio declined by -34%. The de-rate followed, with an additional -34% decline, despite flattish/slightly up earnings revision for 2024E. Although it could be argued that the de-rate was partly justified as shares were trading at a P/E of 60X going into Q4 results (above one standard deviation versus historical average), the current discount may have been excessive. This raises a question whether the growth concern is temporary, with the multiple eventually expanding closer to the historical average, or if LULU shares deserve a lower multiple going forward. In fact, as mentioned previously, the Power of Three x 2 plan already incorporates lower growth prospects going forward, especially in the core US market. However, despite the upbeat tone in Q1, same-store sales in the North America division were flattish yoy. Although it is true that this can be partly explained by the strategic missteps during the quarter (demand for Lululemon products seems strong), I believe that for a multiple expansion to occur, the market must be confident in the growth trajectory of the North America division (closer to the plan's guidance). Currently, I don't think this is the case. Image created by author with data from company and Seeking Alpha Valuation framework suggests limited upside My valuation framework incorporates a DCF with a 9-year forecast and terminal value. Lululemon has a significant portion of its value in perpetuity (67%), and the company has no debt. Although this is positive from an operational perspective, considering the current scenario of high interest rates, the cost of equity becomes very expensive and impacts valuation, especially considering a company with a high growth profile. My model incorporates a perpetuity growth rate of +5.0% (roughly the historical growth rate of nominal GDP in the US), and a cost of capital of 11.0% (11.0% cost of equity, 30.0% tax rate, and 4.5% risk-free rate). The model output suggests a 12-month price of $350.00, yielding a potential upside of +15% versus the current price (as of June 13). It is important to mention that given Lululemon's capital structure, consisting of 100% of equity (ex-operating leases), and its high-growth profile, the valuation is very sensitive to small changes in the discount rate. For reference, assuming a -50bps change, the model output yields a +25% change, all else equal. Image created by author with data from company Sensitivity analysis reinforces this view I conducted another sensitivity analysis to assess the sensitivity of EPS to changes in sales and margins over the next three years. The output was used to conduct another analysis, examining the sensitivity of EPS and the P/E multiple to estimate the internal rate of return (IRR) during the same time period. The S&P500 delivered an average annual total return of approximately +15% over the past 15 years, so I used this as a benchmark to compare the level of IRR required to generate an excess return or \"alpha\" (stock return minus index return) when investing in Lululemon shares. For the period FY23-26E, the model assumes a sales CAGR of +11% and a total cost CAGR of +10.4%, resulting in a EPS CAGR of +14.2% (including share buybacks). At current forward P/E multiple of 21.4X (-54% discount to the 5-year average), the three-year IRR would generate +8% annual average return, which is roughly half the threshold of +15%. Alternatively, assuming the same top-line/EPS growth, the multiple would have to expand at least +19% to yield the market return (IRR of +15%). Considering current trends, I see this re-rate as unlikely in the near-term. The risks are: (1) top-line is below the +11% average return during the period; (2) the company will experience margin contraction; and, (3) the multiple will remain the same or deteriorate further. Comparing Lululemon's PEG ratio to those of peers and companies in the tech sector (due to their high growth profiles), it suggests that Lulu shares could have room for a re-rate. By plotting the PEG ratio against consensus EPS CAGR over 3 to 5 years for Lululemon, industry peers (Under Armour (UAA), Crocs (CROX), Lululemon (LULU), Deckers (DECK), Skechers (SKX), On Holding (ONON), and Adidas (ADDYY)), and selected tech companies (Apple (AAPL), Microsoft (MSFT), Google (GOOGL), Amazon (AMZN), Meta Platforms (META), Netflix (NFLX), and Nvidia (NVDA)), Lululemon shows a PEG ratio of 1.77 (EPS of +13%), which is below the PEG ratio for NKE (2.35), DECK (2.83), and UAA (4.28), despite higher EPS expectations. Although one could argue that this should be enough to justify a multiple re-rate even at a lower average baseline going forward, hence justifying a potential upside, I think it also reinforces the view that, even trading at a discount on a relative basis, the market is not paying upfront. This suggests the company must first prove it can sustain growth in its core market before it deserves any multiple re-rate.   Image created by author with data from company and Seeking AlphaImage created by author with data from Seeking Alpha The model incorporates growth moderating but margin expanding The model forecasts top-line growing at a CAGR23-32E of +10.4% (market expects global athleisure segment to growth at CAGR24E-30E of +9.3%), with revenues reaching $13.1bn in FY26E versus the expected revenue of $12.5bn in the Power of Three X 2 plan. From the baseline of $13.1bn in FY26E (after the plan), total revenue is expected to grow at a CAGR26-32E of +10.0%, with an average CAGR26-32E of +6.0% for the North America division and +16.8% for the International division (China +15.6%). For reference, these estimates assume growth will be cut in half versus the previous period (i.e., Power of Three plan x 2), when the North America division was expected to grow on average by +10% and the International division by +32%. Moreover, this assumes International achieving approximately 44% of total revenues by FY32E. From FY26E to FY32E, the network is expected to grow at an average annual rate of +4.0%. Notably, the estimates at the North America division suggest Lululemon would lose some share (the market forecasts North America growing at +8.4% from 2024E to 2030E). In contrast, Asia-Pacific is expected to grow at +10.3%, suggesting share gains as Lululemon expand the presence and enter new countries within the region. Additionally, it is assumed some gross margin contraction over the long-term due to increased competition, which could be seen as conservative given some offset from increased exposure to e-commerce, which command higher margins. The model assumes flattish gross margin in FY24E (in line with guidance), -180bps reduction versus the 2023 baseline (from 58.3% to 56.5%), and +60bps versus 2019 levels. Moreover, the model assumes operating leverage and efficiency gains, translating into a 28.5% EBITDA margin at the end of the forecast period (+195bps versus the 2019/2023 baseline). EPS is expected to grow at an average of +14.2% over the next three years, including the share buybacks. For the next three fiscal years, estimates in the model closely align with consensus estimates, with average revenue/EBITDA in the model being -0.2%/+0.6%, respectively. Image created by author with data from companyImage created by author with data from companyImage created by author with data from company and FactsetImage created by author with data from company and own estimates Risks The main risk to the investment thesis is that growth in the core geography decelerates faster than expected. As discussed, management execution is important to ensure that Lululemon can sustain growth in its largest market, which in turn could support a multiple re-rate. Moreover, a deceleration in sales within the International division, primarily in China, could weight negatively on market sentiment, suggesting the company is unable to sustain double-digit growth levels. This could also lead to further multiple contraction. Competition is also a concern, especially in the US, with new entrants announcing aggressive growth plans in the coming years. Lastly, the company is also undergoing significant internal changes, with the recent announcement of its Chief Product Officer leaving to join a peer. Although the company announced internal changes and mentioned that in-house talent will help address the issue, this could lead to potential disruption in the innovation pipeline should the transition is not smooth. Concluding thoughts  Lululemon has a unique business model that allows for greater engagement with customers. Despite near-term headwinds the broader industry has been experiencing, the company seems to be navigating well by leveraging its omnichannel capabilities and untapped international markets. Soft trends within its core market suggest strategic missteps, rather than a lack of demand for its products. This is encouraging considering the challenging consumer environment, which in turn reinforces the idea that Lululemon has the capability to quickly adapt and create interest in the brand. Secular trends will continue to provide tailwinds for Lululemon, which I see well-positioned to compete and still having significant room to increase its presence overseas. Yet, despite the significant de-rate, I believe the market will remain on the sidelines, waiting for greater conviction that the company can sustain strong growth in core regions. Until then, I don't see any catalyst that would lead to a multiple re-rate.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2443524642"}