Vancouver, Canada-based athleisure fashion retailer Lululemon Athletica Inc. (LULU) is set to join the S&P 500 index on October 18, replacing video-game company Activision Blizzard Inc., which Microsoft Corp. (MSFT) recently acquired for $68.7 billion after crossing numerous regulatory hurdles. The announcement was greeted with a more than 10% surge in LULU's shares.
Historically, the news of inclusion in the S&P 500 positively impacted stocks, usually driven by increased liquidity and heightened interest from individual and institutional investors.
Let’s look into the investment cases for the activewear giant’s shares.
Boasting a market cap of over $50 billion, LULU continues its stride amid the turbulence rattling the broader apparel industry. The company has leveraged the pandemic-driven trend of home exercising, acquiring smart fitness platform Mirror for $500 million to tap into the flourishing at-home fitness sector. This acquisition was intended to fuel further purchases of LULU clothing.
However, this landmark M&A transaction faced obstacles in its course. As pandemic restrictions eased globally, a rush toward gyms and fitness studios saw Mirror struggling to retain users. Consequently, LULU had to write down the value of Mirror to a mere $58 million, even considering its sale. By year-end, LULU intends to discontinue the sales of Lululemon Studio Mirror, though service and support will continue for existing customers.
The company underwent a branding exercise, re-emphasizing its product as Lululemon Studio, shifting the attention toward Mirror’s subscription app instead of the hardware device. Despite the setbacks faced by Mirror, LULU’s agility in course-correcting failures speaks volumes of its ability to manage risks, propelling itself into becoming not just a top sportswear brand but also making its debut on the Fortune 500 list.
Recognizing a post-pandemic shift in the fitness industry, LULU has forged a strategic five-year partnership with connected exercise bike manufacturer Peloton Interactive (PTON). This alliance positions LULU as Peloton's leading athletic apparel partner, with select PTON instructors serving as LULU’s brand ambassadors.
However, industry analysts voiced skepticism about the potential marketing benefits, indicating that many PTON users may already be buyers of LULU products. Regardless, the partnership presents evident synergies and opportunities for joint promotion, expected to arise from exclusive product offerings and extended services across both brands, and the advantages attributed to increased scale and reach.
In addition to bike sales, PTON has demonstrated prowess in content creation, live streaming, and launching innovative classes, setting itself apart in the industry. The burgeoning collaboration with PTON bodes well for LULU as it continues to invest in its Studio platform.
LULU's reputation as a fashion retailer catering to affluent consumers has been instrumental in fueling its growth, pointing to its contribution to the conception of the “athleisure” trend, combining fit and high-quality fabric. The company’s gradual expansion into menswear and the recent foray into golf and hiking attire is noteworthy.
Moreover, its experimental approach and avoidance of “analysis paralysis” – an issue that has slowed down many retailers' adaptability to new consumer preferences – have significantly contributed to LULU’s success.
Despite industry-wide challenges, LULU experienced robust growth so far. Its home base, Canada, alongside the U.S., accounted for 78% of its revenue in the second quarter of 2023. During this quarter, the company opened 10 new company-operated stores, totaling 672 stores worldwide.
It also anticipates considerable growth opportunities internationally, particularly in the U.K. and China. LULU is poised to quadruple its international sales, buoyed by remarkable growth in the Chinese market. In the second quarter of 2023, LULU saw a 52% year-over-year increase in global sales. As of July 30, 2023, the company operated 126 stores in China, producing 12.6% of total sales, and Chinese sales spiked 61.3% year-over-year, supported by stable demand after relaxed pandemic restrictions.
LULU’s second-quarter results surpassed Wall Street's forecasts, with net revenue and net income climbing 18.2% and 18% year-over-year, respectively.
Growing Institutional Ownership
LULU’s robust financial health and fundamental solidity make it a compelling investment prospect for institutional investors. Notably, several institutions have recently modified their LULU stock holdings.
Institutions hold roughly 87.5% of LULU shares. Of the 1,173 institutional holders, 489 have increased their positions in the stock. Moreover, 124 institutions have taken new positions (972,619 shares).
Outlook
LULU recently said that it was "off to a solid start" as the North American business improved, which led to an upward revision of its annual revenue and profit projections for the second time this year.
The athleisure wear producer is forecasting its revenue for 2023 to be between $9.51 billion and $9.57 billion, up from the previous projection of $9.44 billion and $9.51 billion. Simultaneously, an anticipated increase in profit is forecasted between $12.02 and $12.17 per share for the same fiscal year.
Stepping into the third quarter of 2023, LULU projects its net revenues between $2.17 billion and $2.19 billion, representing 17% to 18% growth. Earnings per share are expected to be between $2.23 to $2.28 for the quarter.
Furthermore, Lululemon unveiled its strategic aspirations under the Power of Three x 2 growth plan. To fortify its position in the global market, the company desires to multiply its business twofold – soaring from the 2021 net revenue of $6.25 billion to $12.5 billion by 2026.
The cornerstones guiding this ambitious growth map comprise product innovation, unprecedented guest experience, and wide-ranging market expansion. A distinct strategy underlining this objective is to double the revenue flow from men's wear and direct-to-consumer sales and to quadruple the international net revenue compared to figures from 2021.
Analysts expect its revenue and EPS for the fiscal third quarter ending October 2023 to increase 17.8% and 14.2% year-over-year to $2.19 billion and $2.28, respectively.
Bottom Line
LULU continues its journey toward becoming a global brand, displaying strong potential to rival industry heavyweights like Nike, Inc. (NKE) in the long run. This could be traced back to its impressive performance in recent quarters, consistently outperforming Wall Street's profit expectations.
This demonstrates solid fundamental business strength, a strong consumer base, and exemplary operational execution across all corporate levels.
Historically, LULU has been an excellent performer in the stock market. However, following a recent upsurge, its shares now command an even steeper premium. Its shares currently trade at a forward non-GAAP P/E of 34.23x, a 144.2% premium to the industry average of 14.02x.
Despite the increasingly challenging business backdrop, LULU maintains sturdy growth, evident in its recent quarterly report. Yet, considering the current circumstances of high inflation, there is the possibility that the sustained pressure on consumer spending will eventually take its toll on LULU.
Procuring stock at such a premium would only be justifiable because LULU's growth will persevere beyond this financial year and into the foreseeable future.
However, given the broader macroeconomic environment, investors may want to exercise caution and wait for a better entry point.
