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Is Lululemon Stock a Buy in 2023?

consumer discretionary Jan 04, 2023

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Stock: Lululemon Athletica ($LULU)


Now that we're in the new year, it's not just time for the new you, it's time for the new normal in retail. 

We've been harping on this story for a while: 2022 was brutal on retailers thanks to the endless compounding issues that came out of the supply crisis in 2020/2021.

Shipping costs exploded, retailers overbought inventory to make up for it, and consumers started to slow down their spending at the exact wrong time thanks to inflation hammering the economy. 

The result was a near-death spiral of cost increases for most retailers. 

One company that got hit the worst in this inventory whirlpool was Lululemon Athletica ($LULU) which reported last month that they were sitting on a mountain of $1.7 Billion in excess inventory that was absolutely clogging up their free cash flow. 

Other than this short-term inventory catastrophe, LULU has been a standout in retail growth for the past few years.

On the back of an impeccable brand and smart expansion strategies, LULU has been a gold standard for how to compete in retail's new normal. 

That masterclass seems to be continuing with Lululemon's inventory and inflation woes mildly abating in 2022.

Frankly, we see the 17% correction in the stock price that came after their December earnings call as more of a temporary buying opportunity than anything.

LULU is really setting itself up to stretch their brands in all the right ways at the exact right moment in this downturn. 

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

Lululemon 2022 Overview:

If you ignore the heavy selloff that hit back in December, it was a surprisingly solid year for Lululemon.

Rising costs and foreign exchange issues ate into Lululemon's margins just like anyone else, but LULU has the same advantage as every luxury brand -- e.g. their products can take on a lot of rising costs, and their main consumer is more than willing to take on a higher price point. 

After a tough 2021, LULU managed to pull off a 28% increase in revenue YoY.

The only problem there is the massive amount of supply chain, administrative, and FX issues that actually caused their profitability to go down from 57% to 55%.

A 55% gross margin off of that level of revenue is awesome, but the market is always forward-looking with this kind of stuff, so the stock got rocked on that news. 

Because, in some scenarios, it's easy to see how this is a problem that could easily get worse for LULU. Not only are they being hammered by shipping and supply chain issues, but in order to get a handle on that, they overproduced their inventory and are now sitting on a $1.7 Billion pile of unsold goods that is seriously slowing their free cash flow. 

All of these issues combine into serious potential headwinds for the brand moving into 2023. That is until you go a little further under the hood and see all the processes powering that immense increase in revenue. 

 

Lululemon is Gaining All The Right Momentum:

Lululemon has thrived off of completely cornering specific niches of the market. They have overwhelming support in North America and from women, specifically. 

But a lot of their recent revenue growth has come from two very specific cohorts that they have very little penetration in: China and men. 

  • China's growth is ready for a breakout: Which is honestly a crazy statement. 95% of apparel brands barely make a dent in China, but LULU's growth there is starting to look exciting. Lululemon has nearly tripled the number of stores they have in China to 105 from 38 in 2019. This is only 30% of the number of stores they have in the US, but this growth is WILD and in more affluent cities over there. Furthermore, LULU is actually having success using mid-tier brand ambassadors and local influencers to grow like wildfire in China. They're growing effectively and cheaply -- which is enough to give us confidence that they'll pull off a lot more growth there by 2025. 

  • Men are starting to become a real cohort.  Lululemon is doing a solid job shifting from being primarily for women to being a full-spectrum brand. They're powering this by focusing on men in their international growth, and that success is giving them the insights they need to convert all their US and Canadian stores into shops optimized for both genders. They're currently at 25% penetration for their potential men's market penetration, and they only really need to grow a few more percentage points for flywheel effects to kick in and give them a solid runway moving forward. 

Besides those two major growth areas, we're also eager to see when they can make their acquisition of the MIRROR company profitable.

MIRROR is an in-home workout studio that $LULU is selling alongside a $40 subscription service that helps users plan and execute workouts.

Obviously, tech like MIRROR is expensive to produce right now, but those costs are decreasing across the economy.

We're really excited to see growth in that subscription service though because recurring revenue is always the holy grail in this economy. And SaaS multiples like this can readily correct other issues in Lululemon's margin growth. 

All this growth is really solid to see and is enough for us to have a lot more confidence about adding to our LULU position throughout this downturn.

Frankly, this correction puts LULU in a really attractive 35x P/E valuation. That's way less spicy than other plays and right in line with our other brand pick, Nike.

 

Lululemon Outlook:

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

Lululemon has demonstrated that they are capable of thriving in this environment. Despite their massive inventory issues, they recently have started getting shipping costs under control. 

Their growth is impressive, and they have all the pieces they need to really take off with MIRROR and their Lululemon Studio subscription.

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. 

Like we said before, this recent correction is just a solid opportunity to grab LULU at a great 35x revenue multiple. Lululemon is downright cheap compared to other retailers, and right in line with their biggest competitor, Nike. 

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: $41B

P/E Ratio: 35x

Dividend Yield: N/A

Risk/Reward: Medium/Medium