(Source: Yoga class in a Lululemon store.)
Lululemon (NASDAQ:LULU) is a good company with solid fundamentals, a positive vibe, a community-type culture, and more growth potential. It is known for having the best quality yoga pants, its signature product, but I dont believe Lululemon has enough of a competitive advantage to be a stable long term investment.
Today, we’ll look at the solid long-term fundamentals of the company. Next, we’ll see why I believe LULU shares are overpriced. Then we’ll examine who’s buying and selling this stock and what the technical indicators are saying about LULU. We’ll look at the pros of this company and then at the cons and risks. In the conclusion, I’ll decide whether Lululemon has enough of a competitive advantage to be a stable long-term investment.
Lululemon Athletica has an 84.625/100 company rating according to the BTMA Stock Analyzer. It has strong historical (5-10 year) fundamentals for upward price per share, consistently rising earnings, market crash recovery, return on equity, return on invested capital, and gross margin.
(Source: BTMA Stock Analyzer – company rating scores)
(Source: BTMA Stock Analyzer – 10 years of earnings)
Return on Invested Capital
One of the most important measurements to examine is Return on Invested Capital or Return on Capital Invested. This tells us if the company is doing a good job of investing the shareholders money. On the surface, the numbers are good, but a weakening or inconsistent economic moat can be seen when looking at the ten-year Return on Invested Capital data starting from 2008 (left) to 2017, and the last number being TTM. You can see that it went from over 40% down to about 21% over these ten years. This could be a sign that the competition is catching up. Potentially, Lululemon is losing its competitive advantage.
(Source: – return on invested capital)
Value Vs. Price
According to a conservative estimated discounted cash flow, the intrinsic value of LULU stock is in the range of low to mid $50s. An average of multiple conservative valuation methods of the BTMA Stock Analyzer produced an intrinsic value range of $50-60. Recently, the share price has been around the mid-$70 range, which could indicate that the shares are now trading at a premium price. If prices could dip below $50, then this could be a decent price to currently buy this stock.
(Source: BTMA Stock Analyzer discounted cash flow intrinsic value of stock)
There have lately been more shares of LULU added to portfolios than decreased from portfolios. Below, youll see that 10,198,566 shares have been added vs. 10,107,070 shares decreased. Additionally, there have been more new shares purchased (3,161,879) than shares sold out (2,287,216). Therefore, according to these numbers, it would suggest that investors are positive about LULU overall and investors continue to take new positions in this stock. This increasing demand for the stock could help to push the share price up further, at least for the short-term.
(Source: LULU new and added positions)
(Technical analysis is showing an upward trend and momentum of LULU as it recently surged in price from around $67 to $75. On the other hand, the surge may be slowing down as LULU is now showing an indication of being overbought.)
The Advantages of Lululemon Athletica
Lululemon has a long-standing reputation. In 2018, the company will be providing the same vision and product for 20 years.
Lululemon leads the industry in creating some of the most innovative and highest quality yoga and active wear apparel.
In addition, Lululemon should continue to have strong growth in the near future as yoga pants are becoming more popular as a lifestyle change of daily fashion wear or at a minimum, yoga pants are a hot trend that should continue for at least a few more years. With this in mind, I can comfortably say that Lululemon should have no problem in maintaining or continuing to sell a growing number of active wear in the next 5-10 years if the current trend continues.
Lululemon has the advantage of frequently selling the same products multiple times to the same customer. Fitness clothes take a beating and wear out or get damaged from sweat, stretching, and mishaps. Therefore they need to be replaced every so many months or years depending on the activity level of the customer. In addition, if a customer works out or wears Lululemon clothing several times a week, then they will likely want to have various items and styles so they won’t wear the same smelly clothing every time.
Lululemon has developed innovative styles, textures, and “feels” for its clothing (especially yoga pants) that can be considered unique to some consumers. Therefore customers might buy various items depending on the feel of compression, silkiness, or the feeling of “nakedness”.
Even more unique than Lululemon’s clothing, might be its store experience. It offers free yoga classes in some of its stores, running clubs, and free tailoring or hemming of some pants and shirts to provide a better fit. This is somewhat unique at the time being, but other competitors are not prohibited from also offering the same types of services.
Lululemon does have a strong fan base of loyal customers, especially among young and active ladies. It also seems to have some culture of followers that could continue to grow as many people still haven’t heard of Lululemon.
Lululemon has much room to grow and is expanding globally. Internationally, Lululemon has opened 11 stores across Asia and Europe, and it is particularly interested in expanding more into China, where its CEO sees significant potential.
The company’s online and direct to consumer sales account for almost 20% of revenues, and this is an area that the company is trying to increase.
In January 2015, the company entered into a license and supply arrangement with a partner in the Middle East locations of the United Arab Emirates, Kuwait, Qatar, Oman, and Bahrain for an initial term of five years. Lululemon keeps the rights to sell its products through its own e-commerce websites in these locations. Under this arrangement, it supplies the partner with the products, training and support.
In November 2016, the company entered into a similar agreement with a partner to operate Lululemon branded retail locations in Mexico for a term of ten years. It also keeps the rights to sell through e-commerce websites in Mexico.
(Source: 2016 Annual Report)
Here is a running total of all stores as of January 29, 2017:
Lululemon operates over 400 stores, which make up for about 70% of revenues and direct-to-consumer digital sales account for approx. 20% of revenues. The remaining revenue comes from wholesale, showrooms, and outlets.
(Source: 2016 Annual Report)
Lululemon gives me a feeling of trust, quality, and good reputation after learning about the history and vision of the company, from listening to CEO Laurent Potdevin speak about the movement of the company, and from hearing from customers and employees. These feelings of trust, quality, and reputation hold some value, however unless you seek out this information, it is hard to understand how this adds significant value to the company. I fear that this intangible value that is clearly seen by younger generations and Lululemon’s fan base of mindful people that share in their community will possibly be overlooked by analysts, data-driven investors, and institutional investors which probably have more influence over the share price of the stock, at least in the short term.
Risks of Investing In LULU
There are some industry-wide risks and company-specific risks involved when investing in any company. The industry-wide risk of investing in LULU mostly involves the retail woes faced by most physical retail stores. Large companies like Amazon (NASDAQ:AMZN) that are a dominant force in e-commerce sales can threaten to take away some of Lululemons sales as more people rely on Amazon for their online shopping.
Lululemon has plans to move into more mall locations as mall traffic is declining and mall stores have been closing more rapidly in recent years.
Lululemon doesnt have a great track record of online customer service. Return – waiting for almost 3 months!
Lululemon needs to constantly spend more money on research and development to modify its clothing in order to stay in the forefront of the active wear industry. This expenditure reduces its profit margins, but is necessary unless it develops a well-protected and patented line of clothing that is timeless. It’s likely that the company will continue to spend on R&D because it believes in being innovative in its fabrics and product lines. According to the 2016 Annual Report:
“Our design team identifies trends based on market intelligence and research, proactively seeks the input of our guests and our ambassadors and broadly seeks inspiration consistent with our goals of style, function and technical superiority. As we strive to continue to provide our guests with technically advanced fabrics, our design team works closely with our suppliers to incorporate innovative fabrics that bring particular specifications to our products.”
Lululemon does attempt to maintain its value by using patents, but these patents are limited in their power to prevent competitors from producing similar products. Even Lululemon admits this in its 2016 Annual Report:
“…because we hold limited patents and exclusive intellectual property rights in the technology, fabrics or processes underlying our products, our current and future competitors are able to manufacture and sell products with performance characteristics, fabrication techniques, and styling similar to our products. The intellectual property rights in the technology, fabrics, and processes used to manufacture our products generally are owned or controlled by our suppliers and are generally not unique to us. “
Therefore, Lululemon has no concrete way to prevent competition or to protect the very aspects of its business that make them successful. It can only rely on the faith that customers will continue to be loyal to its brand and hope that the competition doesn’t take away its market share by producing similar products at better prices. Realistically, it doesn’t seem like a sustainable plan. Therefore, the company would be better off to work on better ways to make real advantages to make its product and services unique and to effectively protect these advantages to prevent competition from successfully competing with them.
Since Lululemon uses outside suppliers for its fabrics and raw materials, it is vulnerable to any delays or consequences caused by labor unions of its suppliers. Ultimately, these factors leave the company at a loss of control.
Much of the value in this company is intangible value that is hard to measure and often not realized in the share price. For instance, there is value in the energizing community atmosphere and culture of Lululemon. It promotes positive well-being and mindfulness. It offers free tailoring services, free yoga classes, running clubs, free yoga mats during classes, and a place to hang out with like-minded people. But the question still remains if investors and analysts will appropriately take into account for this intangible value.
I like the vibe of the company, its vision, and the quality of its products. It does have a strong fan base of loyal customers, especially among young and active ladies. It has a following and some sort of culture that it has built around a customer experience and this culture should continue to grow as the trend for more daily active wear and yoga pants is still on the rise. The unique culture and atmosphere of the company does add some sort of economic goodwill, but this intangible value is hard to measure and doesn’t necessarily translate into increases in share price. The question also remains if this loyalty and intangible value will continue to grow or maintain into the long-term future.
Lululemon does attempt to protect its assets by using patents, but these patents are limited in their power to prevent competitors from producing similar products.
Therefore, Lululemon has no concrete way to prevent competition or to protect the very aspects of its business that make them successful. The company can only rely on the faith that customers will continue to be loyal to its brand and hope that the competition doesn’t take away its market share by producing similar products at better prices. Realistically, it doesn’t seem like a sustainable plan. Therefore, the company would be better off to work on better ways to make real advantages to make its product and services unique and to effectively protect these advantages to prevent competition from successfully competing with them.
I personally feel that an investor could make significant gains from riding the short-term growth of this company, but without stronger patents and a real economic moat, I cant full-heartedly have faith in this company as a long-term investment.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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