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  • KPB & Co Research

Following a blockbuster financial year where revenues grew 24.1%, adjusted operating profit 26%, and earnings per share (EPS) 64%, the management team at Lululemon unveiled their new 5-year plan. When the 2020 plan was presented we outlined at the time, that the plan could be achieved even if the company went into auto pilot mode. Today, the company is on track to exceed the plan in the coming fiscal year, and so have announced a new plan that calls for another 5 years of stellar growth in revenues, and profits with a touch of margin expansion. When all is taken into consideration, management expects to grow the business by an annual amount in the low teens, but is this really credible given the nature of the business, and the industry? We think the plan is credible because of the fact that the company has broaden ed their addressable market significantly, and has also made the necessary investments in infrastructure to support growth.

The New 5 Year Plan

According to the Lululemon management team, the company is expected to grow in the low teens through the following:

  1. Product innovation: Company intends to create new products for both men (2X increase) and women in old and new product categories accessories. The company intend to sell more accessories, and create new products in the yoga, running, training , Office/Travel/Commute and self-care categories.
  2. Omni guest experience: The company is expecting to more than double its direct to customer business by 2023. According to the company, they will " focus on offering an integrated guest experience across channels which are intended to inspire, provoke and celebrate guests who live a healthy and mindful lifestyle across multiple experiences".
  3. Market expansion: The company expects to grow its international revenues by a factor of 4 by 2023, through expanding in China, Asia Pacific Countries, and the Europe Middle East, and Africa regions. The company will also continue deliver on the market potential that exists in North America.

Lululemon Today

With a fiscal year 2018 revenues of US$3.3Bn, Lululemon currently is in an enviable financial, operational, and market position. The company has very minimal financial leverage, which we estimate to be approximately 29% of total Invested capital on account of the estimated US$600Mn due to operating leases, and no corporate debt. With more than US$881 million in cash and equivalents, the company has negative net debt. The company's free cashflow of US$517Mn is approximately 86% of the lease liability. From an operational perspective, the company is one of the most efficiently operated business. The company has a gross profit margin of approximately 55% - in the top tier of the industry, an adjusted Operating margin of 22%, net Profit margin of 14%, and Return on capital of 30% - also top tier in the industry. The company has a very strong brand, an excellent social media presence, and has largely re-built their reputation among millennials. We think it is safe to say that the company's customers are fans that are well in-tuned with the company's message of an active mindful life style.

Walking up-stream in retail

Lululemon has been going against tide in retail with back to back high single digit expansion in comparable store sales even in the face of continued increase in store square footage. To be fair, Lululemon is unlike most retailers in the sense that they have a lot of control over the guest experience both online and in-store, and that they have quasi-control over the manufacturing process (through third party contractual agreements), and full control over product design. This puts them in enviable position of being able to respond to customers needs fairly quickly. The vertically integrated nature of the company has allowed them to generate US$1,579 in sales per SQFT, with each store averaging 3030 SQFT. These numbers are very impressive when one considers the number of retail bankruptcies in last 5 years.

But is the plan really Credible ?

The company has hinted at a number of strategic moves that if undertaken will broaden the addressable market, and provide them with a credible shot at increasing their stake in the US$115Bn global sports apparel market. Perhaps one the key strategic moves is the desire to go into the footwear category after testing the category through a partnership with APL. According to the Calvin McDonald - CEO:

We tested and we learned a lot on footwear and what we learned is: The [customer] resonates with us selling footwear

This move will serve to broaden the company's addressable market immensely, as the size of the global Athletic footwear market was estimated at US$ 37.76Bn in 2017, growing at a CAGR of 5.1% in the near term. Another product line the company will expand into is selfcare. The selfcare category includes deodorant, dry shampoo, basic balm and face moisturizer, with a focus on on product function, feel and format. This product line appear to born out of the feedback that have been provided by the Athletes in the Lululemon community, and will likely grow with the size of the company's customer base.

Lululemon also aims the double the men's by 2023, and with the changes they have made we think it is possible. The men's business is expected to hit just over a US$1Bn in sales by 2020. Today, just over 40% of the sales to men are due to women inspiring their boys to buy the product, but the company has made important steps to inspire men to buy Lululemon's product on their own initiative. The company recently signed Nick Foles as a brand ambassador. Foles is one of the most sought after quarter back in the NFL today, and was the 2018 Super Bowl MVP.

The company also have other product categories that are currently at the fledgling stage, but could be developed in the next year or so. In June 2017, the company went into a strategic partnership with 7mesh, which is a startup that focuses on selling high performance cycling apparel. Though the company did not mention much about the partnership, we think the vision here is similar to that of the APL deal, where the partnership initially involved use the company's retail stores to sell APL's shoes, and then later evolved into shoe design and manufacture.

The international market opportunity represents Lululemon's strongest potential for growth, given the depth of the brand and the population dynamics in areas where the company already has a presence. China alone has 400 million millennials, and 772 million online users, with 76% of the urban population involved in some physical activity. The company also has a strong opportunity for growth in Europe, where in recent times there have been an inflection point in growth in the UK market. Currently the international business accounts for approximately US$360Mn, it quite likely that the company can grow that business 30% CAGR over the medium term.

Company has invested in the Infrastructure To Support Growth

Since Advent international took a stake in the company, the company has made the necessary investments into the growth platform, particularly in supply chain management. According to the company:

Capital expenditures related to corporate activities and other were $90.2 million, $57.7 million, and $62.7 million in fiscal 2018, fiscal 2017, and fiscal 2016, respectively... In fiscal 2018, we also undertook various information technology infrastructure and corporate system initiatives. This included the continued development and implementation of our new enterprise resource planning system that will help improve our merchandising, costing, allocation, and inventory platforms.

Additionally, the company also secured another 250k SQFT distribution facility in Toronto, Ontario which increases the company's distribution capacity by 30+%. We expect this capacity increase to support growth of the North American market. There will likely be additional capacity instalments over the planning horizon. Furthermore the distribution of suppliers, with 58% of products manufactured in South East Asia, 21% in South Asia, 12% in China, 8% in the Americas, allows the company to maintain a responsive supply chain while optimizing on cost.

Lululemon is in a good position to achieve their growth objectives over the next 5 years. They certainty have done the necessary work to establish a growth platform, and to large extent we have seen evidence early successes. On the other hand, a lot of the success the company has had over the last 4 years can be attributed to the discipline and direction of the Advent International - the private equity company that essentially took control of management. The private equity company has been gradually reducing its exposure in the company, which given their holding period leads us to believe that they are exiting soon. Like many other growth companies, there are enormous execution risks involved that my surface if a strong leadership team is not in place.

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