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Witnessing A Stunning Turnaround at Lululemon

consumer discretionary Apr 04, 2023

Price Target: Unlock 🔐 

Target Date: Unlock 🔐 

Stock: Lululemon ($LULU)

We're closing out this brief focus on apparel with a quick look at Lululemon's ($LULU) barn-burner of an earnings call. 

If you read our reports on Nike and On Running last week, you'll notice there's a big trend forming in retail -- e.g. brands are getting their inventory under control, and gearing up to completely blow past their scary inventory surpluses by the second half of the year. 

We're honestly surprised Lululemon is even in this conversation. Compared to market cap (~2% of their entire market cap was just their inventory weighing down their free cash flow), their inventory woes were some of the worst in the business. 

But once again, luxury branding has saved the day here, allowing LULU to pull off a pretty strong liquidation without eating into their gross margin or profitability too much. 

In the age of inflation, it pays to have that luxury branding. 

Meanwhile, LULU has also established a strong international expansion in the last quarter and lived up to what we needed them to. 

The only key difference here is LULU allowing themselves some more optimistic guidance than the likes of Nike -- which is bringing a LOT of confidence back to the sector. 

Don't call this a comeback, but stocks like Lululemon are signaling improvements for the whole economy.

There's a lot to be excited about, and just enough to be worried about. 

But there's a lot more to cover on why this stock can deliver strong returns, so let's get into it ðŸ‘‡ 

How to Beat Your Inventory Woes:

So Lululemon had a fairly solid 2022 until they were hit with a pretty steep selloff in the wake of revelations that their inventory was rapidly getting out of control.

From Q3 2021 to Q3 2022, inventory grew at a staggering 83% year-over-year.

This meant Lululemon was sitting on an unconscionable $1.7 billion in excess inventory. 

This is the key problem for brands to solve in 2022 and 2023.

There is a small, yet real, chance this may be the final problem stemming from the complete collapse our consumer economic system suffered in 2020.

Brands overbought revenue to get around supply chain issues just in time for rising prices to blow everything up. 

Any brand that gets its inventory under control without causing a discount death spiral is going to get out of this just fine if inflation manages to keep calming down. 

And that's what's causing Lululemon to absolutely go nuts in the last few weeks. This quarter, LULU pulled off only 50% inventory growth, leaving them with "only" 1.5 Billion in revenue to deal with. 


Lulu's Numbers:

Let's be real, that number is still staggering, but it shows that Lululemon did a solid job of using the holiday season to push way more inventory without discounting too much.

Their margins only declined by ~0.7%. And if you look back to our last two reports on Nike and On Running, you'll see that we (and the wider market) were praising a ~3% reduction in margins.

This is a way smaller loss and speaks to how powerful Lululemon's brand is. 

Furthermore, Lulu's guidance for the year pointed at their ability to get inventory down to the ~35% range and achieve 'clean' levels of inventory growth sometime in the second half of the year.

Lululemon is a standout in being an apparel brand not fully pricing in some kind of slowdown coming down the pipe. We love to see that.

The main point here is the strength of Lululemon's luxury brand. They didn't have to burn their house down in order to tackle these inventory issues.

We cannot express enough what an act of logistical and fiduciary wizardry that is.   


Lululemon Outlook:

Sometimes all you need is the right kind of growth to take you out of a slump.

We're really impressed with LULU's ability to get their inventory under control.

Again, this has a small chance of being the "final boss" of the COVID-era downturns for consumer brands like Lululemon. 

At this point, MIRROR has turned into a non-issue for the stock. We need to see A LOT of growth coming out of that line before we start feeling any kind of excitement for the company. 

Their store growth was solid in Q4, but once again, we need to see them accelerate their Chinese growth before we get more aggressive in our price target for them. 

We want to get more concrete numbers about how many North American stores are being optimized for men, but we're confident they can keep that growth going in the right direction. 

All the signs point to the positive. but we've got a long way to go here.

We're really excited to see what they can keep pulling off. 

Rating: Overweight

Market Cap: $46B

Dividend Yield: N/A

Risk/Reward: Medium/Medium