Can New Leadership Help Lululemon Regain Proper Form?

By: SumZero Staff | Published: April 01, 2014 | Be the First to Comment

I believe Lululemon Athletica is undervalued at its current price most likely due to lack of confidence in the company after several mishaps in 2013. It's been about a year since 15-20% of the company's trademark yoga pants were recalled due to the product being too sheer. The company is also several months past a PR nightmare in which the chairman and founder Chip Wilson made some negative comments. With the company now moving through these "growing pains" combined with a new CEO and other executive management, LULU shares could trade up significantly over the next 24 months and beyond.

*Premium active brand
*Distinctive retail experience
*Innovative design process
*Community-based marketing approach
*Solid fundamentals

*Despite sales that continue to grow, gross margins and ebitda margins peaked in 2012.
*Although it's been a year since sheer pants were recalled, customers will now think twice before they drop $100 on yoga pants.
*The stock price is down some 34.5% since 12/31/2012 while the market is up some 33.1%. This could leave a sour taste in some investors' mouths, which will make them reluctant to get back into the stock until progress is seen.
*The company recently reduced 4Q13 guidance at the beginning of January citing a slowdown in traffic. If one looks at a map of store locations they will see that a significant number of stores are in the Midwest, East, and North East. I believe this slowdown was due more to inclement weather than a loss in interest in the LULU brand.

*International expansion
*Brand development
*North America expansion
*Develop DTC Channel
*New and more appealing products
*Negative stock sentiment

*Obviously as an athletic apparel company LULU faces significant competition. On top of that, the company is a premium retailer so a lot of competitive products are being offered at much lower price points. Finally, the company is up against far bigger companies with much more operational experience and deeper pockets such as NKE, UA, Adidas, amongst others.
*As the company expands internationally earnings could become more volatile as fx rates change.
*Since the company is geared toward a higher-end consumer any stock price or house price volatility could affect consumer net worth, which could lead to less discretionary spending and would be a risk to LULU.

Valuation (Updated 3/27/14):
LULU currently trades at roughly 23.6x my forecasted 2015 deps and roughly 12.94x my forecasted 2015 ebidta. On the company's 4Q13 and fiscal 2013 conference call management noted that 2014 will be an investment year where the company will invest in its supply chain and expand internationally.

My new estimates reflect increased spending due to these comments and I have also updated my model to accompany 2014 guidance. While I realize there is only some 21-22% upside between current prices and my 2015 YE estimate I believe my estimates are conservative as I derived my price target from an average of my P/E estimate and my EV/EBITDA estimate (25x 2016 deps of $2.55 and 17x 2016 ebitda).

If the company executes on its supply chain and international initiatives and/or sales are better than expected the stock could be rewarded with higher multiples. I believe there is a strong likelihood of this happening as I am impressed with new management's prior successful endeavors. Simply put, if you don't believe in the brand and the growth of the brand over the next several years then this stock is not for you.

*New management - Laurent Potdevin took over as the company's new CEO on January 20, 2014. Previously Mr. Potdevin worked as the President of Toms Shores, was the CEO of Burton Snowboards, and was also an executive at LVMH. Along with a new CEO, the company hired a new Chief Product Officer in Tara Poseley. Prior to joining LULU, Ms. Poseley held positions at Kmart Apparel, Bebe Sport, The Disney Store, Design Within Research and Gap Inc. Finally, the company also recently hired Felix Del Toro as SVP and head of Men's and Jennifer Battersby as SVP of Sourcing, Quality, and Communications.

*The company will announce 4Q13 earnings BMO on March 27, 2014. Current consensus (estimize) sees Revenues of $516.15MM (up 6.3% yoy) and Earnings of $0.72 (down 4% yoy).

*Analyst Day is April 17, 2014. This will be the first analyst day with the company's new management team. I believe the company will reaffirm its targets of 55% gross margins and 25% operating margins.

*I believe if the stock trades significantly lower ($40 or below) over the coming year, the company will be bought out by a larger brand developer such as VF Corporation.

Closing Thoughts:
It's obviously not going to be easy for the company to turn around in a quarter or two, but with previously successful new management, solid fundamentals and the worst being priced into the stock with a short interest of some 20-21%, I believe LULU represents a solid opportunity for anyone that wants to take advantage of a young and growing athletic-lifestyle brand. Unless one thinks the company is absolutely going to fall apart I would recommend buying the stock ahead of earnings. I recognize the multiple could remain compressed relative to history and peers, but as the company executes over time I believe they will be rewarded with a higher valuation.


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