Lululemon: The best company in its sector.
Once investing, you are always searching for the best company in a given sector, and if we are looking at the athletic clothing sector, I believe Lululemon qualifies 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 57,7 % and an operating margin of 21,3 %, which is higher than companies like Nike, Adidas, Under Armor, 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 the time of writing this analysis, I do not own shares in Lululemon nor in any companies that are direct competitors (I own shares in Crocs though). If you want to copy the portfolio or want to see which stocks I hold, you can read 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 that one should keep an eye on. It has since been on my watch list, but I have yet to initiate a position.
Lululemon was founded in 1998 in Vancouver, Canada. It is a designer, distributor, and retailer of athletic apparel and accessories. Their products are designed for various athletic activities, but the company is especially connected to yoga. In 2020 they diversified a bit as they acquired MIRROR, which is an in-home fitness company with an interactive workout platform that features live an on-demand classes. Their largest customer group is women, which represented 67 % of their 2021 revenue, while their largest geographical market is North America, which represented 85 % of their 2021 revenue. Lululemon has three business segments: Company Operated Stores (45 % of revenue in 2021) Direct to consumer (44 % of revenue in 2021), and Other, including MIRROR (11 % of revenue in 2021). Lululemon operates 574 stores across the globe, in which 324 are in the United States. China is the country with the second most stores, as 86 of the stores are in China. Investigating moat, I believe that Lululemon has a strong brand moat. One example of the strong moat is that transactions among both new and existing customers are increasing without price promotions. Furthermore, Lululemon could increase their price due to the current inflation without experiencing price resistance. And finally, Lululemon continues to gain market share, and was the largest share gainer in the sector in last quarter.
The CEO is Calvin McDonald. He first joined Lululemon in 2018 and has been the CEO since. Prior to joining Lululemon, Calvin McDonald was the president and CEO of Sephora America's. 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 in the Walt Disney Company. Calvin McDonald has done a remarkable job as Lululemon has delivered double-digit revenue growth annually under his leadership. He is known as a growth-oriented leader with a proven track record helping large organizations scale, innovate, and elevate customer engagement on stores and across digital channels. According to comparably, Calvin McDonald has an employee rating that places him in top 5 % of similar sized companies, which isn't surprising as he in an interview mentioned that honesty and transparency are qualities that he aspires to lead by. All in all, I feel very comfortable with Calvin McDonald as the CEO of Lululemon as he has delivered remarkable results while he has a high employee rating.
I believe that Lululemon has a brand moat. I feel very confident in the management as well. 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 investment 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 every single year the last ten years. It is hard to find much negative to say about the ROIC. Sure, the numbers dropped a bit during the pandemic, but they are picking up again. I would be very happy to see numbers like these if I were invested in Lululemon.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. There have been some years in which the book value has increased slightly but it is nothing to worry about. Equity does tick up a bit in 2020 with the acquisition of MIRROR but it is very reassuring to see that Lululemon is growing their equity ever since.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditure. The first thing that springs to mind is that Lululemon has delivered a positive free cash flow every year in the last ten years, which is always nice to see. The decrease in 2020 is because of the acquisition of MIRROR, and it is encouraging to see that Lululemon grew their free cash flow again in 2021. Furthermore, it is very nice to see that 2022 has, by far, been their best year ever. Hopefully, it bodes well for the future.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by earnings. However, it isn't possible to make the calculations on Lululemon, because Lululemon has no debt. It is obviously a great thing, and very encouraging to see.
Based on my findings so far, I believe that Lululemon is an interesting company. However, no investments are without risk and Lululemon has some risks as well. Different macroeconomic factors. There are different macroeconomic factors that could hurt Lululemon in the short-term. In the latest earnings call, management mentioned that ocean freight times are still significantly elevated compared to the pre-COVID period, which results in Lululemon using air freight instead. Air freight is more expensive, which means that margins for Lululemon are decreasing. One example is that gross profit margin in Q2 2021 was 58,1 % compared to 56,5 % in Q2 2022. Furthermore, the current economic state could result in a recession. And while management mentioned that they still haven't seen shifts in spending patterns, consumer spending does usually drop during recession, and you would ought to think it will also affect Lululemon. Dependent on the North America market. Lululemon are expanding internationally but currently, North America represents 85 % of the revenue for Lululemon. Hence, they are very dependent on the North American market. Looking at the GDP growth forecast in the United States, GDP is expected to grow by 1,4 % in 2022 and 0,3 % in 2023. GDP growth is expected to be higher in Canada but the dependency on the North American market could slow down Lululemon. Competition. In their annual report Lululemon mentions competition as a risk. They mention that the market for athletic apparel is highly competitive and that their competitors have a size and resources that may allow them to compete more effectively than Lululemon can. It may result in pricing pressures, reduced profit margins, and losing / not growing their market share.
There are also plenty of potential for Lululemon in the future. One that is particularly interesting is their very ambitious five-year growth plan called Power of Three x2. In the next five years Lululemon wants to double their business to reach a revenue of $12,5 billion, and management have a clear plan of how to do so. They want to double the revenue in men's sales, double their revenue in digital sales, and quadruple their international sales. You may think that is sounds overly ambitious, but management delivered before. Their previous plan was called the Power of Three, in which they managed to double men's sales, double digital sales, and quadruple international sales in approximately three years. The Power of Three x2 is the growth strategy of Lululemon but there are also other positives. New products. Lululemon continues to introduce new products. In 2022 the introduced footwear to their product portfolio. The athletic footwear market is expected to reach $165 billion by 2030, and you ought to think that Lululemon will have a slice of that. Lululemon are also expecting to introduce other products along the way. However, the most interesting product they will introduce is their two-tier membership program. One will be free, and one will be paid and be connected to MIRROR. The paid will result in recurrent revenue, while the free will give Lululemon the possibility to capture consumer data to better meet their customer's needs, while a program like this also keeps the costumer more engaged with the brand. Finally, Lululemon is also doing buybacks. In my opinion, buybacks are usually always positive unless the stock price is too elevated. Currently, Lululemon has $830 million left of their $1 billion repurchase program. Hence, the number of outstanding shares is slowly decreasing.
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 7,49 which is the EPS of 2021, Lululemon expects a higher EPS in 2022. I chose an Estimated future EPS growth rate of 15 (management expects higher growth but it is the highest I use), Estimated future PE 30 (which the double of the growth rate, as the historically PE for Lululemon has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $224,7, and we want to have a margin of safety on 50 % so we will divide it by 2, meaning that we want to buy Lululemon at price of $112,35 (or lower obviously), 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 1.389,1 The Capital Expenditures was 394,5. 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, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 276,15 in our further calculations. The Tax Provision was 358,5. We have 129,768 outstanding shares. Hence, the calculation will be like this: (1.389,1 - 276,15 + 358,5) / 129,768 x 10 = $113,40 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 6,82 and a growth rate of 15 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $107,59.
I believe that Lululemon is a very interesting company. They have been growing at a high pace and have developed a very strong brand moat. The CEO has done a remarkable job and I feel confident in the management. It is hard to predict how economic downturn will hurt the company but with a strong moat and no debt, I feel confident that Lululemon will get through it easier than many other companies. I would like to see Lululemon continue to grow internationally, so they won't be as dependent on the North American market. Hence, it is encouraging to see that it is something that management is focusing on. I would love to own Lululemon as I think it will compound over the years, as they have high margins and a high ROIC. I would need it to get around intrinsic value before I would even consider starting a position, and I will be most comfortable to buy Lululemon around the $200 mark.
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