Lululemon AthleticaInc.
/ (LULU-NASDAQ)/ Equity Research / LULU | Page 1
Current Recommendation / NEUTRAL
Prior Recommendation / Underperform
Date of Last Change / 10/10/2014
Current Price (10/09/14) / $41.07
Target Price / $43.00
We have upgraded our long-term recommendation on Lululemon to Neutral based on its better-than-expected secondquarter results and an upbeat fiscal 2014 earnings forecast. The results mainly benefited from the company’s ongoing strategies, of product and brand enhancement as well as global expansion. Moreover, with Advent’s men joining its board some optimism has started circulating for the company. However, we remain slightly cautious about the stock given the rising competition in the activewear product line as large sporting goods and apparel retailers are attempting to capture market share in the female yoga, running, dancing and stylish casual compression pant product lines.Furthermore, the prevalent soft macroeconomic environment and volatile raw material prices remain concerns.
SUMMARY
/ Equity Research / LULU | Page 1SUMMARY DATA
52-Week High / $75.8852-Week Low / $37.25
One-Year Return (%) / -44.45
Beta / 1.62
Average Daily Volume (sh) / 3,987,103
Shares Outstanding (mil) / 143
Market Capitalization ($mil) / $5,887
Short Interest Ratio (days) / 6.87
Institutional Ownership (%) / 71
Insider Ownership (%) / 28
Annual Cash Dividend / $0.00
Dividend Yield (%) / 0.00
5-Yr. Historical Growth Rates
Sales (%) / 36.1
Earnings Per Share (%) / 44.9
Dividend (%) / N/A
P/E using TTM EPS / 22.0
P/E using 2014 Estimate / 23.2
P/E using 2015 Estimate / 20.3
Zacks Rank*: Short Term
1–3 months outlook / 2 - Buy
* Definition / Disclosure on last page
Risk Level * / Above Avg.,
Type of Stock / Large-Growth
Industry / Textile-Apparel
Zacks Industry Rank * / 60 out of 267
OVERVIEW
Founded in 1998 and based in Vancouver, Canada, Lululemon Athletica Inc. is a yoga-inspired athletic apparel company that creates lifestyle components. The company designs, manufactures, and distributes athletic apparel for women and men. The company offers a line of apparel and accessories, including fitness pants, shorts, tops, and jackets designed for athletic pursuits, such as yoga, dance, running, and general fitness under the Lululemon Athletica brand name. Its fitness-related accessories comprise an array of items, such as bags, socks, underwear, yoga mats, instructional yoga DVDs, water bottles, and headbands. The company sells its products primarily in North America through a chain of corporate-owned and operated retail stores, independent franchises, and a network of wholesale accounts. The company has also recently launched an e-Commerce site and aims for rapid expansion of its online business.
The company operates in three segments: Corporate-Owned Stores, Direct-to-Consumer, and Other. As of Aug 3, 2014, it operated 270 stores in North America, Australia and New Zealand under the lululemon athletica and ivivva athletica brand names.
REASONS TO BUY
Superior Design and Premium Pricing to Bring Laurels: Lululemon is one the leading yoga-inspired athletic apparel and accessories retailer with operations across North America. The company has a niche positioning in the market due to its superior product designs and premium pricing, despite the recent product mishaps. Further, the company has an edge over its competitors on grounds of innovation as its superior pricing allows it to experiment with fabric and designs. Lululemon works with yogis and athletes in local communities to carry on continuous research and receive product feedback. Moreover, we remain impressed with the company’s favorable demographic and secular trends that ensure top line growth over the longer term.
Rising Estimates on Upbeat FY14 Guidance: The Zacks Consensus Estimate for Lululemon has witnessed upward revisions over the last 30 days after the company posted better-than-expected secondquarter results and raised its earnings outlook for fiscal 2014. We believe that the results benefited from the company’s ongoing strategies of product and brand enhancements and global expansion.With a positive surprise of 13.8% in the reported quarter, the company has now surpassed the Zacks Consensus Estimate for 25 consecutive quarters. We expect the company to keep up this trend of posting positive earnings surprises going forward as it continue to focus on boosting productivity at existing stores, developing e-Commerce retail platform and enhancing its presence, both domestically and overseas.
Advent Comeback Raised Optimism: Looking at the recent developments it seems that Lululemon’s troubles might soon come to an end. We believe that the end of the prolonged standoff between the company and its founder along with the involvement of private equity partner, Advent International, in its management have raised hopes regarding the company’s return on growth trajectory.The private equity firm had previously invested in the company in 2005 and exited in 2009. Between these periods, Lululemon witnessed tremendous growth and became a globally recognized premium yoga-apparel brand from a regionally focused brand. Therefore, we are optimistic for the company’s growth prospect.
Immense Growth Potential Through Market Penetration and e-Commerce Growth: We believe that the company possesses an unmatched level of long-term growth opportunity in the industry based on its potential to expand square footage and enhance its business globally as well as by expanding its ivivva model. Moreover, the company has the ability to drive impressive top-line growth by focusing on e-Commerce retailing channel and investing in innovation of new product categories. The company ended second-quarter with a total of 270 company-owned stores under the Lululemon and ivivva brand names in the U.S., Canada, Australia and New Zealand. While the Canadian market seems mature, we believe there remains scope to expand across the U.S. as well as in the underpenetrated European and Asian markets which contribute less than 10% to sales.
REASONS TO SELL
Black Luon Setback and Negative PR Impact Traffic: Lululemon has been in troubled waters since Mar 2013 when the company was forced to recall its Black Luon yoga pants and crops from its stores and e-Commerce site due to quality related issues. This created a lot of buzz in the press, which coupled with controversial comments from Lululemon’s founder that hurt the sentiments of its women customers, led to lower traffic trends in the company’s stores throughout fiscal 2013 and fiscal 2014 so far, thus, impacting the company’s overall results.
Competition: Lululemon has been an elite and premium activewear brand, having established itself as a market leader in the yoga apparel segment. However, the picture has been gradually transforming since last year’s product recall, which created a shortage of supply for almost three quarters. This provided an opportunity for leading brands like Gap, Nike, Nordstrom, L Brands, Under Armour and other private and boutique brands to capture market share in the female yoga, running, dancing and stylish casual compression pant product lines.
Macroeconomic Challenges: The apparel retail industry is consumer-driven and hence, is very sensitive to health of the economy. Spending on apparel and accessories is heavily dependent on the personal disposable income of the consumers. The current macroeconomic challenges such as high household debt and unemployment levels may restrain consumer spending on these items.
RECENT NEWS
Lululemon Q2 Earnings & Revenues Beat – Sep 11, 2014
Lululemon’s second-quarter fiscal 2014 earnings of $0.33 per share cruised ahead of the Zacks Consensus Estimate of $0.29 as well as the company’s forecast of $0.28–$0.30 per share.
Results benefited from the company’s ongoing strategic move towards product and brand enhancements and global expansion. However, earnings plunged 15.4% on a year-over-year basis.
Lululemon’s quarterly revenue advanced 13.4% to $390.7 million, beating the Zacks Consensus Estimate of $377.0 million. Revenues also came ahead of the company’s previous forecast of $375–$380 million.
Comparable-store sales (comps) remained flat during the quarter on a constant dollar basis, including a 30% increase in Direct-to-Consumer comps, offset partially by a 5% decline in corporate comps.
Moreover, Direct-to-Consumer revenues of $63.5 million in the quarter constituted about 16.2% of the total revenue, compared to 14.3% in the prior-year quarter.
Quarter in Detail
Gross profit rose 6% to $197.3 million from the prior-year quarter. However, gross margin contracted 350 basis points (bps) to 50.5% in the second quarter of fiscal 2014, owing to a fall in product margin due to unfavorable sales mix and greater input prices. However, this was partly compensated by improvement in markdowns.
Selling, general & administrative (SG&A) expenses increased nearly 21% to $129.4 million, while as a percentage of sales it expanded 200 bps to 33.1%. Higher SG&A expenses resulted from a rise in operating expenses at new stores as well as higher wages across all stores, increased variable costs for operating the online business and higher expenses at store support center.
Following this, income from operations slumped 14% to $67.9 million while as a percentage of sales, it contracted 550 bps to 17.4%.
Glance at First Half Fiscal 2014
For the six months ended Aug 3, 2014, Lululemon’s earnings tanked 35.2% to 46 cents per share while sales jumped 12.3% to $775.3 million.
Other Financials
Lululemon exited the quarter with cash and cash equivalents of $725.1 million, inventories totaling $176.5 million and stockholders' equity stood at $1,126.7 million.
In the second quarter of fiscal 2014, Lululemon incurred capital expenditure of $26.7 million mainly for the opening of new stores, renovation of existing stores and expenses related to IT and head office capital.
Store Update
During the reported quarter, the company opened 7 corporate-owned stores including 5 in the U.S., 2 Ivivva stores and 1 store in Australia-New Zealand, which was offset by the closure of 1 store in Australia. Overall, the company ended the quarter with a total store count of 270 compared to 266 last year.
Guidance
Lululemon projects third-quarter sales in the range of $420–$425 million on the back of low single-digit comps growth. The company anticipates third-quarter earnings in the $0.36–$0.38 per share range. However, the guidance does not include the impact of planned share repurchases.
For fiscal 2014, Lululemon now expects revenue in the range of $1.78–$1.80 billion with combined comps growth in the low single digits. Earlier, the company had projected revenue of $1.77–$1.80 billion.
Lululemon projects adjusted earnings in the range of $1.72 – $1.77 per share, compared to $1.71–$1.76 per share projected earlier. Including the one-time tax adjustment related to the planned repatriation, earnings for the year are expected to be in the $1.51–$1.56 range.
VALUATION
Currently, Lululemon trailing 12-month earnings multiple is 22.0x compared with 32.3x, the industry average and 18.1x for the S&P 500. Over the last five years, Lululemon’s shares have traded in the range of 20.6x to 64.3x trailing 12-month earnings. The stock is trading at a discount to the industry average based on forward earnings estimate for fiscal 2014 while at a premium based on fiscal 2015 earnings estimate. Our target price of $43.00 based on 24.3x 2014 EPS, reflects this view.
Key Indicators
Earnings Surprise and Estimate Revision History
DISCLOSURES & DEFINITIONS
The analysts contributing to this report do not hold any shares of LULU. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts’ personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will underperform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1121companies covered: Outperform- 16.1%, Neutral- 77.8%, Underperform – 5.7%. Data is as of midnight on the business day immediately prior to this publication.
Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company’s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock’s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively.
/ Equity Research / LULU | Page 1