lululemon athletica inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Lululemon is a global athletic apparel, footwear, and accessories company known for its premium yoga-inspired products and athletic wear. The company’s direct-to-consumer and omnichannel retail strategy drives revenue and growth.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Moat Assessment: 3/5

Lululemon demonstrates a narrow but solid economic moat, characterized by a mix of brand strength and some limited switching costs:

  • Brand Recognition and Premium Pricing Power: Lululemon has cultivated a strong brand associated with quality, high performance, and a specific lifestyle (athletic, mindful, and well-being). This brand equity allows them to command premium pricing, typically at the high end of the market for athletic wear. As an example of this, they had a net revenue increase of 19% to $2.2B and a net income of $290M in the most recent quarter.
  • Limited Switching Costs: Although it isn’t necessarily a high switching cost, Lululemon cultivates a loyal customer base. Some degree of “brand loyalty” means that customers don’t switch out quickly to other competitors. Lululemon’s “member” programs also increase this stickiness by incentivizing customers to purchase more through unique benefits, including early access, invites to events, access to exclusive promotions, etc. That also creates a switching cost by forfeiting those benefits if they decide to move to a competitor. For example, Lululemon’s brand affinity is higher in mature markets, like North America, compared to Europe where the brand is still building recognition.
  • Differentiation Through Design and Community: Lululemon’s fabrics and products are differentiated, and a focus on functionality and style for athletic-related activities. Lululemon also focuses on community-building events and local engagement strategies. In addition, they promote a distinct “mindset” that customers seem to appreciate. This has helped to keep the company relevant and its products valuable.

However, it should also be noted that competitors can and will make similar high quality clothing, and their popularity among customers can quickly change. Lululemon is exposed to shifting fashion trends and has also been hurt by increased competition from new companies, for example, in the athleisure space. These risks limit the moat from being truly wide. Therefore, the moat is considered “narrow”.

Risks to the Moat and Business Resilience:

Several risks could potentially erode Lululemon’s moat and affect its business resilience:

  • Evolving Customer Preferences: Changes in consumer preferences, fashion trends, and performance clothing can quickly make a brand undesirable. This can affect sales and pricing power, ultimately hurting the company.
  • Competitive Market: The athletic apparel market is increasingly competitive, with new brands offering unique products or lower prices. That threatens the company’s premium pricing power. Further, there’s low switching costs for apparel purchases.
  • Supply Chain Disruptions: Although Lululemon has significantly improved their supply chain, potential future disruptions (especially in Asia) can be impactful on their product availability and timelines, reducing the business resilience.
  • Macroeconomic pressures: Although Lululemon has a high brand loyalty and pricing power, it is not entirely immune to downturns. In the event of macro downturn, there is a possibility of customers trading down to less expensive alternatives, hurting the company’s revenues and profits.
  • Global Expansion Challenges: Lululemon is expanding internationally. Different countries have different customer preferences, regulatory landscapes, and supply chain challenges. It also involves additional administrative and overhead expenses which may pressure margins. A good example is China, which is the second-largest market for lululemon behind North America. There have been issues with demand slowdowns related to COVID lockdowns, which have shown the risks of international operations.
  • Brand Issues: As seen with several other companies, public opinions towards a company may change rapidly due to controversies, which can negatively influence the brand image. This may include controversies like unethical employee relations or sustainability practices.

Despite these risks, Lululemon is in a good position to weather any storm. Its high profitability, strong supply chain, and international presence (albeit still small) increases the company’s business resilience.

Business Overview

Lululemon Athletica is a designer, distributor, and retailer of athletic apparel, footwear, and accessories. Here’s a deeper look:

  • Revenue Distribution:
  • By Geographic Segments: The majority of Lululemon’s revenue comes from the Americas region (primarily from U.S and Canada), which generated 85% of their net revenue in 2023. The remaining revenue is distributed to the Asia Pacific and EMEA regions, where they are actively expanding. * Americas: 61% in net revenue * China Mainland: 13% in net revenue * Rest of world: 11% in net revenue
  • By Sales Channels: Lululemon operates through various channels, with the majority of revenue coming from company operated stores and direct to consumer. * Company operated stores: 47% * Direct to consumers: 46%
    • Wholesale: 7%
  • By Category: The company sells a wide range of athletic apparel and accessories for both women and men, including items designed for activities like yoga, running, training, and other forms of athletic pursuits. This includes products like tops, bottoms, outerwear, activewear, intimates, and yoga-related accessories. The company also provides footwear and personal care products. * Womens products: 69% in net revenue * Mens products: 29% in net revenue
    • Accessories: 2% in net revenue
  • Industry Trends: The athletic apparel industry continues to grow globally, driven by the increasing focus on health and wellness and the adoption of athleisure wear. Key trends include:
  • Athleisure: Increased blending of activewear into everyday fashion, blurring the lines between sportswear and casual wear.
  • E-Commerce Growth: Growing importance of e-commerce channels, driven by consumers’ preference for online shopping. This is a particularly important trend, as over 40% of the sales are generated through e-commerce directly.
  • Sustainability: Focus on sustainable production, ethically sourced materials, and environmentally friendly processes has become increasingly important. As a result, Lululemon has a specific set of goals in its sustainability reports and has a long roadmap to implement those.
  • Personalization: Consumers are looking for personalized options and features that enhance their product experience. Lululemon caters to this by offering customization and fit options.
  • Competitive Landscape: Lululemon operates in a competitive environment with major players and smaller niche brands.
  • Major Competitors: Nike, Adidas, Under Armour, and other major sports brands.
  • Athleisure Brands: Athleta, Alo Yoga, Outdoor Voices, and other specialty apparel retailers.
  • Emerging Brands: New direct-to-consumer fitness and activewear brands continue to emerge.
  • What Makes Lululemon Different?
  • Premium Product Positioning: Lululemon focuses on high-quality, performance-driven, stylish products targeted to a more affluent customer base.
  • Community Focus: Emphasis on building a community around fitness and mindful practices, fostering loyalty and brand engagement.
  • Omnichannel Approach: Lululemon balances both physical retail stores and online channels to reach a wide base of customers.
  • Continuous Innovation: They continuously iterate on their products and innovate in new fabrics, apparel, and tech-driven products.
  • Recent Concerns and Controversies: Lululemon has faced some controversies and challenges recently:
  • Quality Issues: The company has had certain recalls over the past year regarding quality control, which was concerning to customers and created negative press. However, management has taken steps to minimize these issues and improve product quality.
  • Pricing Pressures: High inflation has pressured the consumer demand environment, which might lead to slowing revenues. Lululemon has maintained its premium pricing, but has had to adjust in some cases. In fact, recent data from October and November showed the company did have to do some markdowns in products, which might indicate slowing demand in the short-term. This was a cause of concern for investors.
  • Margins: Lululemon has seen its Gross Margins drop from 58.1% to 56.0% in the past 3 quarters due to changes in product mix and increased promotional activity.
  • Inventory levels: There have been concerns on inventory management due to higher than anticipated levels of inventory. Management has since focused on balancing inventory levels to reduce promotional activity and prevent large markdowns.
  • Guidance: After a disappointing end of 2023, where sales didn’t meet expectations, the guidance for the next year is softer than what analysts had predicted.

Financial Analysis

Lululemon has had consistent growth over the past few years. Key financial insights:

  • Net Revenue: Growth has been consistent over the past few years. Lululemon has generated $8.1B in net revenue during the fiscal year 2023. That was a 30% increase over last year. They also increased sales by 19% in the first three quarters of 2024.
  • Margins: The company has had consistently high gross and operating margins. However, recently there has been a significant decrease in margins, with Gross margins dropping to 56.4% and operating margin coming at 18.9% in the most recent quarter. It has been previously seen that Gross margins were often over 58-60% and operating margins were in the low 20s. This indicates a potential change in the future and something investors have to keep in mind.
  • Profitability: Due to high margins, and sustained sales growth, the company has also seen a high profit growth. Net income was approximately $855M in 2023 and has reached 290 million in the most recent quarter of 2024.
    • Cash Flow: They are able to generate high cash flows. The cash from operations was $1.1B last quarter, with $858M of free cash flow. That shows a strong ability for the business to generate high amounts of cash. This free cash flow is important for future investments.
  • Financial Health: Lululemon has a very robust financial position with a significant cash pile and limited debt, giving a balance sheet health of 4/5. However, it should be noted that there has been some increase in debt from the previous year.
    • Investments: Due to strong cash generation, Lululemon has been investing heavily into its business. Total CapEx was $350M last quarter, which is almost 3 times higher than CapEx in 2023. It is primarily focused on technology and store expansions.
  • Share Repurchase Program: They have spent $450M on repurchasing shares last year.

Understandability Rating: 2/5

Lululemon’s business model is moderately complex. Here’s why we give it a 2/5 rating:

  • Easy to Grasp Product: It is easy to understand the company’s products. That means the core offering is athletic apparel and fitness-focused accessories, the core business model of a consumer company is easy to understand.
  • Omnichannel Model: It is clear that Lululemon is moving towards a more omnichannel model, balancing direct-to-consumer, own stores, and third party retail partnerships to generate sales.
  • Complex Supply Chain: While it isn’t too difficult to understand the model itself, the nuances in the supply chain, raw material availability, manufacturing, and relationships with factories and suppliers may be difficult for some investors to understand.
  • Brand Intangibles: Understanding and quantifying the impact of brand perception, customer loyalty, and competitive differentiation is difficult and would need specialized expertise or deep insight into the brand.
  • Financial Nuances: It is becoming increasingly important to analyze the company’s finances, including understanding how they are impacted by inflation, interest rates, and tax laws. In addition, it is becoming increasingly important to understand how the company measures revenue, costs, margins, inventory, and debt.
  • Derivatives: The company has some significant derivative instruments in its balance sheets for foreign currency. They also have various forms of complex stock based compensation and pension plans, that may be hard to analyze.

For those reasons, an understandability score of 2 is assigned. This is for more advanced investors with some background in business and financials.

Balance Sheet Health: 4/5

Lululemon has a strong balance sheet with a decent amount of cash and a manageable debt load. Here’s a summary:

  • Liquidity: Lululemon has an impressive cash balance ($1.86 B), demonstrating very good financial health.
  • Assets: The company’s assets are primarily composed of inventory, which accounts for almost half of their total assets, and property, equipment and lease assets, which contribute another 30%.
  • The majority of the long-lived assets are right-of-use lease assets. Lululemon leases most of its company operated stores, as well as warehouses, distribution facilities, and corporate offices. Those leases are accounted as an asset along with a corresponding liability.
  • Liabilities: The majority of the liabilities are lease obligations ($1.7B) and deferred tax liabilities($500M). It also has a $880M of debt.
  • Equity: Lululemon has $4.5B in equity.
  • Debt Management: Lululemon has manageable leverage which has been somewhat increasing over the last couple of years. They also have strong credit ratings.
  • Cash Flows: The company’s free cash flows are a considerable portion of their net revenues, meaning they have no issues repaying debt, or investing into further growth.

Therefore, the balance sheet is considered robust and resilient and is given a health score of 4/5.