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RIIQ Newsletter

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Every Sunday morning, we publish a free write-up within our RIIQ Newsletter with leading insight and analysis — the aim is to help investors of all skill levels focus on key fundamentals, gain confidence in developing an investment strategy, and gain an edge in the push to generate true wealth.

Grab your coffee and let’s dive in!

In Today’s Newsletter

• Lulu Management’s Missteps: When making any investment decision relative to stocks, it’s critical to also evaluate the quality of a company’s management.

• Taking accountability for management missteps is an attractive characteristic of quality leadership.

• How Short-term Hiccups Potentially Create Market Opportunity.

• Maintain a long-term outlook as applies to investing.

Deep-Dive

INTRO

Today, we're going to talk about Lululemon Athletica because it's a hot topic right now; a lot has happened and it's been reflected in its share price. Let's take a look!

Once again, we won’t drown you in complex math or take more than a few minutes of your time. As we've said before on Raising Investor IQ, information is power. Before making any investment decision, you need to seek out the information you need to make an informed decision.

Now let’s dive in!

A Little Background

Lululemon Athletica, founded in 1998, is a top player in the sports and yoga apparel game, famous for its high-quality leggings and gear. Recently, though, the company's stock has taken a dive (down -54% year-to-date, meaning since January 1^st).

Why? It’s a mix of things: tougher economic times leading to lower consumer spending and some management missteps like a limited product range and stock shortages. These issues have hit sales and shaken investor confidence.

How Macroeconomic Conditions are Rocking Lululemon

Lululemon Athletica (LULU) is having a rough year, and it’s not just because of the gloomy economic outlook. Sure, the tough times are making everyone tighten their belts, but there’s more going on behind the scenes at Lululemon. What’s really happening with this athleisure giant?

When the economy hits a rough patch, people cut back on non-essentials—like that cute new pair of leggings. Lululemon isn’t the only brand feeling this squeeze; it’s a broader trend affecting many apparel companies. But let’s zoom in on Lulu and see what’s really causing the turbulence.

Even though the economic downturn is a big part of the story, Lululemon’s internal issues are making things worse. The company’s leadership has admitted to some mistakes, especially in their women’s line in the U.S. This isn’t just a minor glitch; it’s having a noticeable impact on their performance.

Management Oopsies: what went down?

When making any investment decision relative to stocks, it’s critical to also evaluate the quality of a company’s management. This is a more subjective feat, since assessing quality leadership involves more qualitative analysis as opposed to simply looking at the numbers.

Carefully evaluate management’s decisions via recent articles, publications, and investor relations docs. Dig into the key strategic decisions being made by management, along with how they are allocating capital resources.

So, what’s the deal with Lululemon’s management? They’ve fessed up to a few key errors. For starters, they’ve had trouble with a limited color palette and a narrow range of products, particularly leggings. This lack of variety and issues with stock, especially in smaller sizes, have definitely hurt their performance. They also offer substantial discounts, which may have caused customers to become accustomed to such discounts and therefore reluctant to buy full-price products.

In a recent earnings call, Lululemon’s execs owned up to these problems. This is a key attribute of quality leadership though - taking accountability for management missteps. 

They pointed out that while customers liked the available colors, there just weren’t enough options. Plus, stock shortages in smaller sizes were a recurring headache. These aren’t just minor hiccups; they’re major issues that show the company’s struggles aren’t just about the economy but also about how they’re running things.

Short-Term Struggles, Long-Term Potential

It’s easy to get bogged down by the current struggles, but let’s take a step back.

Lululemon isn’t down for the count just yet. They’ve got a strong brand and a history of bouncing back from tough spots. If they can tackle their management issues and tweak their strategies, there’s a real shot at a comeback. 

For investors, the question is whether to buy now and hold through the rough patches or wait for things to stabilize a bit more. Either way, there’s a chance that the current undervaluation could present a solid buying opportunity.

The stock is trading at record low multiples, setting a low bar for outperformance and making the long-term payoff for LULU attractive. And Lululemon is arguably the highest quality company in its industry, dominating for decades and building a moat in its brand and footprint. Let’s dig in a bit deeper…

Stick to the Plan

Lululemon (LULU) has been catching everyone’s eye, but not in a good way. As we said, the stock has taken a nosedive this year, dropping around 54%. Once the trendsetter in athleisure, the company now faces slower growth and more competition, which has investors feeling jittery.

But even with these recent hiccups, Lululemon is staying true to its game plan. The company’s all about being a premium brand in the sportswear world. This focus on high-quality products helps them stand out, and it’s been a big part of their success. This premium vibe means they’re pulling in strong profits.

For instance, in Q1 2024, Lululemon posted a gross margin of 57.7%. That’s not just impressive—it’s higher than Nike’s. It shows that customers are willing to shell out for Lululemon’s gear. Below is a graph showing the gross profit margin for Lululemon and two of its main competitors, Adidas and Nike.

The company plans to keep rolling with its tried-and-true strategies: community-driven marketing, a focus on direct-to-consumer sales through their website, and a strong presence in their own stores. These approaches have worked well for them in the past, so they’re sticking with what they know.

We can also take a look at the company's level of debt, which can be an indicator for assessing the risk of an investment. Here we see that Lululemon uses leverage sparingly compared to its two competitors:

Growth Goals: what Lululemon is aiming for?

Looking ahead, Lululemon isn’t just sitting around waiting for the storm to pass. They’ve set some big goals with their “Power of Three x2” initiative. They want to double their sales to $12.5 billion by fiscal 2026, compared to 2021 figures.

Here’s what they’re focusing on:

• Doubling men’s and digital sales: they want to significantly boost sales in their men’s line and through their digital channels. These areas are ripe for growth and offer big opportunities.

• Quadrupling international revenue: The company sees a huge chance in expanding its international revenue. Right now, 73% of their sales come from the Americas (including the U.S. and Canada). But they’re seeing impressive growth in places like China, where revenue jumped 45% in Q1 2024. Expanding internationally will open up new revenue streams and help the company grow.

But going global means facing off against some big players. As Lululemon pushes into new markets, they’ll be up against heavyweights like Nike and Adidas as we saw, not to mention local competitors like Anta Sports and Li Ning in China. It’s going to be a tough battle, but Lululemon’s experience and strategy will be key in staying competitive.

 Investor Mood

Right now, of course, the market isn’t exactly buzzing with excitement over Lululemon!

The stock’s big drop this year has left many investors feeling a bit down. Over the past five years, shares have only climbed 33%.

Even with the market’s current pessimism, there’s still potential in Lululemon’s stock. It’s trading at a low forward P/E ratio of 19, which is pretty cheap compared to the S&P 500’s average valuation.

This could be a great buying opportunity for those who believe in Lululemon’s long-term prospects.

After all, maybe it's just the usual fashion industry challenges—changing consumer preferences and stiff competition. Fashion is always evolving, and keeping up can be tough.

Plus, the industry has low barriers to entry, so competition is fierce. But Lululemon has shown it can stay ahead of the curve and keep its brand relevant. Even with rivals like Alo Yoga and Vuori making moves, Lululemon’s strong brand and history of innovation give it a solid footing for the future.

What to Track?

To make smart investment decisions, keep an eye on key metrics like earnings estimates, revenue growth, and valuation. Pay close attention to how the company is deploying capital.

The long-term averages for Lulu’s key profitability metrics such as return on equity (ROE) and return on invested capital (ROIC) have consistently trended both above average and above the levels of key peers. This demonstrates strength in its business model and the presence of a durable competitive advantage. (5-year avg ROE is 35.9% and ROIC is 24.6%). Look for companies with an ROE of at least 10%, and we prefer an ROIC of at least 15%.

As far as the earnings outlook, Lululemon is expected to earn $2.96 per share for the quarter, a 10.5% increase from last year. For the full year, the estimate is $14.27, reflecting an 11.8% increase. For next year, the estimate is $15.69, a 10% rise. All of these projections suggest that the company’s financial health is solid.

For the revenue growth, the consensus estimate for the current quarter is $2.2 billion, up 10% year-over-year. For the current and next fiscal years, estimates are $10.75 billion and $11.78 billion, respectively, showing growth of 11.8% and 9.5%. This growth indicates that Lululemon’s sales performance is on an upward trend.

To understand the valuation, we can use the Lululemon’s current P/E ratio (market price per share divided by the earning per share) and other valuation metrics to help determine if the stock is fairly valued, overvalued, or undervalued in relation to its earnings. Today, the P/E is 19. Back to January 2024, it was 64, meaning that even with a falling stock market price, revenues are stable. That's a very important indicator to take into account!

Conclusion

To wrap-up, Lululemon’s current situation presents both challenges and opportunities. While the company faces significant short-term hurdles, its strong brand, growth potential, and solid financials offer a promising outlook. Investors should weigh these factors to decide if the current undervaluation is a chance to buy or if it’s better to wait for more stability.

You’re now in a better position to dive deeper and decide how to proceed.

Good luck! And if you want more...

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Key Insight

Companies with demonstrated success in deploying capital resources are identified through consistently high levels of key profitability metrics such as ROE and ROIC.

Look for companies with an ROE of at least 10%, and we prefer an ROIC of at least 15%.

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Information provided on this site is based on my own personal experience, research, and analysis, and it is not to be construed as professional advice. Please conduct your own research before making any investment decisions.  I am not a professional financial advisor, stockbroker, or planner, nor am I a CPA or a CFP. The contents of this site and the resources provided are for informational and entertainment purposes only and do not constitute financial, accounting, or legal advice. The author is not liable for any losses or damages related to actions or failure to act related to the content on this website.