Lululemon Athletica

Lululemon Athletica (Photo credit: Carolyn Coles)

By Barbara Gray, CFA – March 24, 2012 – I woke up at 5:24am yesterday and reached over to the nightstand for my IPhone (I ditched my Blackberry back in January 2010 when I elected to leave the corporate world) and immediately went to the CNBC app to check out the stock price of lululemon (LULU-NASDAQ) which was set to report its 4Q11 results before market open. I breathed a sigh of relief as I saw the stock was only trading down 2%. Although I am a strong believer in the company’s long-term growth prospects and view it as a “baby Nike”, its forward P/E of nearly 50 times makes it an ideal short target for investors that are just looking at the numbers.

Although I no longer officially cover LULU, I have a strong personal affinity to both the stock and the company. In addition to being one of the first analysts to initiate coverage on it shortly after its IPO back in September 2007, I actually used to live at 3rd & Arbutus, which is around the corner from its original store in Kitsilano, Vancouver. And as a professional female that lives an active and healthy lifestyle, I am their picture perfect target customer. Although I am not a huge yogi (I prefer more active pursuits as I can never seem to get my type A mind to sit still), I am a huge fan of lululemon and I have the wardrobe to prove it!

Anyways, back to the financials… I took a quick scan through the company’s press release – another impressive quarter! Revenue was up 51% with comparable store sales growth of 26% – and that was on top of 28% growth a year ago. The gross margin was down 250bp to 56.3% (due to higher raw material and labor costs) but the operating margin was up 190bp to 31.2% so the company must have gotten some good fixed cost SG&A leverage. EPS came in at $0.51 up from $0.38 last year – a 38% gain. And the company ended the year with $409 million in cash and equivalents (gotta love a company with no debt!) and 174 stores.

I tiptoed into the living room (hoping Brady would not wake up!) to log onto my computer to listen to the company’s analyst conference call. To be honest, most company conference calls put me to sleep as management just focuses on the numbers. But the conference calls of companies with heart and soul, like lululemon, are different – the tone is much more qualitative and you can tell management actually cares about their stakeholders – customers, employees, suppliers, community, the environment. This was evident in the lululemon call as Christine Day, President & CEO, started off sharing lululemon just reached the $1 billion annual revenue milestone and commented:

“…but far more important than the number itself are the beliefs, values, culture and people that achieved it and our guests that value our products and our guest experience. Our success now and in the future is based on a culture of high performance and leadership development. We find the right talent, empower our employees, teach personal accountability and judgment and share our business strategy at every level across the business to ensure that we engage our employees and give them a sense of purpose.

If you have time, I encourage you to read the entire transcript on Seeking Alpha.

I believe the strong and authentic stakeholder foundation of a heart and soul company, like lululemon, will convert into a high velocity of social capital as the company leverages the high level of enthusiasm and deep psychological attachment to the company’s brand and great purpose. And after sitting through five days of presentations at the recent SXSW Interactive Conference in Austin, Texas, I am even more convinced in my social capital investment thesis as the message I heard over and over again was how companies need to be authentic, transparent, caring, and actually engage with their customers. How else can you explain how lululemon, a company that sells premium-priced discretionary goods, can attract customers into its store and achieve astronomical sales per square foot of over $2000 and a gross margin of over 55%?

There is no doubt LULU will continue to have its skeptics and be a favorite of shorts as most analysts and investors see no need to look beyond the numbers. When I first wrote about lululemon having heart and soul back in January 2011 in my research report titled: “Social Media: An Exposing Disruptive Force – Look for Companies with “Heart” and “Soul” but Beware of “Empty Shells”, the stock was at $67.20 – to my dismay, most institutional investors I talked with said LULU was too richly valued at 48 times earnings and dismissed my qualitative thesis. But I didn’t lose hope and focused even more effort in doing research to further develop my investment thesis.

As I was also busy looking after Brady who was born just before Christmas, it took me 10 months to write my next research report. And while I split my days between working in the coffee in the morning shop and taking Brady out for long walks around the seawall in his stroller in the afternoons (living in my black lululemon pants I have to add!), LULU nicely rose by 67% to $55.98 (it split 2-for-1 in July). In my follow-up report, which I published in November, titled: “Social Capital: A New Strategic Play for Investors – Look for Companies with Heart and Soul”, I once again highlighted lululemon as one of the rare companies with heart and soul. However, from a numbers perspective, the stock still looked expensive at 39 times earnings.

Brady started part-time daycare in the New Year which freed up more time for me to do research and pursue my social capital investment thesis. But it has honestly been an uphill struggle as most investors still believe that companies should be focused solely on maximizing value for their shareholders and are skeptical of companies like lululemon which have a greater purpose and a longer-term value creation perspective. However, once again, lululemon exceeded the Street’s expectations and the stock proceeded to rise another 35% (greatly outperforming the DJIA which rose by 9% over this period). Only time will tell if my social capital investment thesis proves correct…

And in the meantime, with Spring finally here, I can’t wait to check out lululemon’s new line of cycling apparel (it will be nice to actually look good when I cycle!) and I am excited to see the upcoming release of their new swim and surf collection…

Disclosure: I have a LONG position in lululemon athletica, inc. (LULU-NASDAQ; LLL-TSX).



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