Lululemon: The best company in its sector.
Opdateret: 7. aug.
Once you start investing, you are always on the lookout for the top-performing companies in different sectors. When it comes to the athletic clothing industry, I believe Lululemon stands out as the best company. It certainly is if you compare their margins with some of their competitors. In their last financial year, Lululemon delivered a gross profit margin of 55,4 % and an operating margin of 16,4 %, which is higher than what companies like Nike, Adidas, Under Armour, and Puma delivered. Is now the time to buy Lululemon?
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that at the time of writing this analysis, I do not own shares in Lululemon or any companies that are direct competitors. However, I do own shares in Crocs. If you are interested in copying my portfolio or viewing the stocks I currently own, you can find instructions on how to do so here. I first came across Lululemon during my investment workshop with Phil Town, where Lululemon was identified as one of the 10 great companies to keep an eye on. It has been on my watch list, but I have not yet taken a position. If you want to purchase shares or fractional shares in Lululemon, you can do so through eToro. eToro is a very user-friendly platform,and you can get started with as little as $50.
Lululemon was founded in 1998 in Vancouver, Canada. It is a company that designs, distributes, and retails athletic apparel and accessories. Their products are designed for various athletic activities, but the company is particularly focused on yoga. In 2020, they diversified their portfolio by acquiring MIRROR, an in-home fitness company. MIRROR offers an interactive workout platform that includes live and on-demand classes. Their largest customer group is women, which represented 65% of their revenue in fiscal 2023, while their largest geographical market is North America, which represented 84% of their revenue in fiscal 2023. Lululemon has three business segments: Direct to Consumer (46% of revenue in fiscal 2023), Company Operated Stores (45% of revenue in fiscal 2023), and Other, which includes Outlets, Wholesale, Temporary locations, and Lululemon Studio that includes MIRROR (9% of revenue in fiscal 2023). Lululemon operates 655 stores worldwide, with 350 located in the United States. China is the country with the second highest number of stores, with 117 stores located there. I believe that Lululemon has a strong brand moat. One example of the strong moat is that Lululemon grows its number of customers without price promotions or discounts, and Lululemon has no intention of changing from being a full-price business. Furthermore, Lululemon could increase its prices due to the current inflation without experiencing price resistance. Lululemon continues to gain market share and was the largest share gainer in the sector last quarter.
The CEO is Calvin McDonald. He first joined Lululemon in 2018 and has been the CEO ever since. Prior to joining Lululemon, Calvin McDonald was the President and CEO of Sephora Americas. While he also has experience from the retail sector in Canada. He has an MBA from the University of Toronto and a Bachelor of Science degree from the University of Western Ontario. Besides being the CEO, he also serves on the Board of Directors of Lululemon as well as on the Board of Directors of the Walt Disney Company. Calvin McDonald has done a remarkable job as Lululemon, delivering double-digit revenue growth annually under his leadership. He is known as a growth-oriented leader with a proven track record of helping large organizations scale, innovate, and elevate customer engagement in stores and across digital channels. According to Comparably, Calvin McDonald has an employee rating that places him in the top 5% of similar-sized companies. This is not surprising, as he mentioned in an interview that honesty and transparency are qualities he aspires to lead by. All in all, I feel very comfortable with Calvin McDonald as the CEO of Lululemon becausehe has delivered remarkable results and has a high employee rating.
I believe that Lululemon has a strong brand moat. I also have a lot of confidence in the management. Now let us investigate the numbers to see if Lululemon lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will investigate is the return on invested capital, also known as ROIC. We want to see 10 years of history, and we want the numbers to be above 10% in all years. Lululemon has delivered above the requirement in everysingle year for the last ten years. It is hard to find much negative to say about the ROIC. Sure, the numbers dropped a bitduring the pandemic and again in a challenging macroeconomic fiscal year 2023. Nonetheless, I would be very happy to see numbers like these if I were invested in Lululemon.
The following numbers represent the sum of the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the percentage growth year over year. There have been some years in which the book value has decreased slightly, but it is nothing to worry about. Equity did tick up a bit in 2020 with the acquisition of MIRROR, but it is very reassuring to see that Lululemon has been consistently growing its equity since then.
Finally, we will investigate the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use the margin to better understand it. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share.The first thing that comes to mind is that Lululemon has consistently generated positive free cash flow for the past ten years, which is always encouraging to observe. The decrease in 2020 is due to the acquisition of MIRROR. It is encouraging to see that Lululemon has once again grown their free cash flow in 2021 and 2022. However, the challenging year of fiscal 2023 has had a negative impact on free cash flow, and I hope to see Lululemon return to free cash flow growth in fiscal 2024. Leveraged free cash flow reached a record 15,9% in 2022 but decreased significantly in fiscal 2023. The free cash flow yield has never been particularly high, indicating that Lululemon has never been inexpensive.
Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a manageable debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by earnings. However, it isn't possible to make calculations on Lululemon because Lululemon has no debt. It is obviously a great thing and very encouraging to see.
Based on my preliminary findings, I find Lululemon to be an intriguing company. However, no investments are without risk, and Lululemon also has some risks. Dependent on the North American market. Lululemon is expanding internationally, but currently, North America represents 84% of the company's revenue. Hence, they are highly dependent on the North American market. Looking at the GDP growth forecast in the United States, GDP is expected to grow by 0,7% in 2023 and 0,4% in 2024. GDP growth is expected to be higher in Canada (1% in 2023 and 1,3% in 2024), but the dependency on the North American market could slow down Lululemon. A small percentage supplies and manufactures much of their products. Lululemon doesn't manufacture any of their products themselves, which means they are very dependent on their suppliers. Approximately 56% of their products were manufactured by their top five vendors, with the largest vendor manufacturing 15% of their products. Regarding fabric, 56% of their fabrics were produced by their top five fabric suppliers, with the largest supplier producing 21% of their fabric. Furthermore, Lululemon does not have any long-term contracts with any of their suppliers. Hence, if they were tolose their largest suppliers, it could adversely affect their business. Acquisitions like MIRROR. While I do feel confident in management, I would like for them to refrain from makingacquisitions that do not necessarily fit within the core business of Lululemon. Lululemon acquired MIRROR for $500 million in 2020. However, in fiscal 2022, the company had to take a $442,7 million impairment charge related to the acquisition. Management has mentioned that sales of the MIRROR hardware have been disappointing. As a result, they have decided to incorporate MIRROR into their paid loyalty program, Lululemon Studio. This means that customers willno longer be required to purchase the hardware. Hopefully, we won't see any more of these acquisitions in the future.
There is also plenty of potential for Lululemon in the future. One particularly interesting aspect is their ambitious five-year growth plan called Power of Three x2. In the next five years, Lululemon aims to double its business and achieve a revenue of $12,5 billion. The management has a clear plan in place to accomplish this goal. They want to double the revenue from men's sales, double the revenue from digital sales, and quadruple their international sales. You may think that sounds overly ambitious, but management has delivered before. Their previous plan was called the Power of Three, in which they successfully doubled men's sales, doubled digital sales, and quadrupled international sales in approximately three years. Low brand awareness. Outside of North America, Lululemon still has low brand awareness. While brand awareness in the international market is growing, it is still relatively low. Lululemon has a brand awareness of 24% in Australia, 9% in China, and 16% in the United Kingdom. Management sees this as a significant opportunity for Lululemon, as there aremore consumers who are unaware of the brand compared to those who are aware of it. One way that management wants to build brand awareness is by opening new shops. This strategy appears to be effective, as Lululemon's sales per square foot increased from $1.443 in fiscal 2022 to $1.580 in fiscal 2023. Growing their membership programs. Lululemon has introduced a two-tier membership program. One of the membership programs offered by Lululemon is a paid membership called Lululemon Studio, which includes access to MIRROR. The other is the free membership program called Lululemon Essentials, which was introduced in October 2022. According to management, the number of sign-ups has significantly exceeded their expectations, as more than 9 million people havesigned up for one of the two programs. Of those 9 million people, more than 30% have participated in at least one of the benefits of the program. Management expects that engagement in the Lululemon Essentials program will drive retention and increase purchasing behavior in the future. Thus, the two membership programs should drive long-term value for Lululemon.
All right, we have gone through the numbers, potential and risk regarding Lululemon, and now it is time for us to calculate a price for Lululemon. To calculate price, we will need the numbers that I have explained in the "MY STRATEGY" section of the website, as I do not want to go through the whole calculation here. I chose to use an EPS of 6,68 which is the EPS for fiscal year 2023. I chose an estimated future EPS growth rate of 15% (management expects higher growth, but this is the highest rate I use). I selected an estimated future PE of 30 (double the growth rate), as the historical PE for Lululemon has been higher. Additionally, we have already established a minimum acceptable return rate of 15%. Doing the calculations, we arrive at the sticker price (also known as fair value or intrinsic value) of $200,40. Since we want to have a margin of safety of 50%, we will divide it by 2. This means that we want to buy Lululemon at a price of $100,20 (or lower, of course) if we use the Margin of Safety price.
Our second way to calculate a buy price is the Ten Cap price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating cash flow last year was 966 The capital expenditures were 639. I tried to look through their annual report to see how much of the capital expenditures were used on maintenance. I couldn't find it, though. As a rule of thumb, you can expect 70% of the capital expenditures to be used for maintenance. This means that we will use 477 in our further calculations. The tax provision was 478. We have 127,321 outstanding shares. Hence, the calculation will be as follows: (966 - 477 + 478) / 127,321 x 10 = $75,94 in Ten Cap price.
The last calculation is the Payback Time. I also described in "MY STRATEGY". With Lululemon's Free Cash Flow Per Share at 2,57 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $40,57.
I believe that Lululemon is a very interesting company. They have been growing at a rapid pace and have developed a highly robust brand moat. Outside of the MIRROR acquisition, the CEO has done a remarkable job, and I feel confident in the management. It is difficult to predict how an economic downturn will impact the company, but with a strong competitive advantage and no debt, I am confident that Lululemon will navigate through it more smoothly than many other companies. I would like to see Lululemon continue to expand its international presence, reducing its reliance on the North American market. Hence, it is encouraging to see that management is focusing on it. I would love to own Lululemon because I believe it will experience compounding growth over the years due to its high profit margins and return on invested capital (ROIC). I would need the price to reach its intrinsic value before I would even consider starting a position, and I will be most comfortable buying Lululemon around the $200 mark.
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