Stephanie Link: Can Outcast LULU Be the Darling Again?
By: Stephanie Link
| 03/05/14 - 12:57 PM EST
NEW YORK (TheStreet
) -- It's been a pretty volatile last 12 months for sports apparel maker, Lululemon (LULU)
. After being the darling on Wall Street for many years with double digit growth, superior execution and exciting sports apparel products, the company stumbled in 2013 and shares have fallen 34% from its highs.
I might be a bit early on this one, but I like it here. First off, I like the category growth potential as lifestyle and health trends continue to explode higher, which are positive secular tailwinds for the stock and the industry. The industry size is enormous for global sportswear, standing at $250 billion, growing at high single digit rates. In the U.S. the market is expanding at double the rate of traditional apparel at $80 billion in sales. Just about every woman I know wears one of these brands for comfort, style and performance. In North America, there are really just 4 big time players - Nike (NKE)
, Under Armor (UA)
, Gap's (GPS)
Athleta and LULU. Internationally, Adidas
is also a formidable competitor with a $23 billion market cap.
We own and like Nike in Action Alerts Plus, Jim Cramer's Charitable Trust, because of its industry dominance with superior returns, a strong balance sheet and Direct-to-Consumer growth opportunities. It also is in the process of turning around its China operations and, in doing so, is positioned for positive operating leverage in 2014. And at 23x forward earnings estimates, the valuation is reasonable.
I also admire Under Armor from afar with its strong products and market share gains, though trading at 60x forward estimates, it's a bit rich for me. The Gap owns Athleta - my personal favorite, but I don't really want the other parts of the company given the run up in its shares. LULU is down and out and my recommendation is based on my belief that the many problems it had in 2013 will get fixed under new management which will lead to a higher stock price. With sentiment so low, not much has to go right in my view. It has a small share of the market - at $1.5 billion in sales ($1 billion in the U.S.) and room for growth internationally (under 10% of total sales), new product categories (swim, daywear, running), and menswear. The square footage growth also is a plus with the company expected to reach 350 total US stores in the next two to three years, up from the current 166-store base. Finally, Direct-to-Consumer (DTC) and e-commerce initiatives will further drive growth.
So let's go back to last year. It was rough, with product recalls, delivery delays, and higher freight costs. The CEO resigned unexpectedly and the non-executive chairman and founder also stepped down. In March, the company had to recall one of its most successful products - the Luon yoga pant, because the material was see through. This product alone accounted for 17% of its women's bottoms and had a big impact on earnings, sales and same store sales. Not to mention confidence of its consumer. The recall alone hit earnings by 20 cents, sales by $40 million to $45 million and hit same store sales by 4 to 5 points. It then had delivery delays, manufacturing issues, supply chain problems and higher freight costs - another 10 cent hit to the bottom line. The CEO Christine Day resigned and the founder and non-executive Chairman, Chip Wilson, stepped down. In just a few months the company went from darling to fallen angel and the speed at which the business turned was staggering.
Enter new management -- the new CEO Laurent Potdevin joined in January. Potdevin started his career at LVMH, spent 25 years at winter sports maker Burton Snowboards as COO and then CEO and also at Toms Shoes. The company also has a new Chief Product Officer, Tara Poseley, who will head merchandising, inventory, allocation and strategic planning. She has 25 years of experience at Kmart Apparel, Bebe Stores, the Gap, and Disney Stores. Her products won't be out until the end of this year but just having someone dedicated to product design and quality will be a positive. Assisting her is Jennifer Battersby, who is VP of Sourcing. We'll get a product update and further strategy initiatives at the compay's April 17 analyst day - which we believe will be a positive catalyst for shares.
Clearly there are concerns out there - competition, EBIT margins have fallen for 2 years and management will need another round of investment spend to further build out the business which could put a lid on operating leverage in the near term. Not to mention - can they get back the lost customers? I wouldn't be surprised to hear a "kitchen sink" kind of guide for the full year at the analyst meeting in April largely tied to investment spend increases and further supply chain initiatives - but I think a lot of that is now priced into the shares - especially after the company already lowered guide back in January. The stock is down 34% from its high and trades at 23x forward estimates - well below the historical average of 37x. EBIT margins have come down from the peak 2012 of 27% but at 24% they remain ahead of UA at 12% and NKE at 14%. It has easy comparisons ahead and $5/share of cash on its balance sheet. Patience will be required for this one, but I like the risk/reward.
--Written by Stephanie Link in New York.Action Alerts PLUS, which Link co-manages as a charitable trust, is long NKE.