ByYorkville Investor:
Lululemon (
LULU
) is overvalued, and you should short it. By all conventional
metrics that we employ, Lululemon appears overvalued:
Lululemon's meteoric rise as an iconic branded clothing retailer
has obscured the apparent disconnect between the admittedly strong
fundamentals and the downright unreasonable valuation. Lululemon's
existing valuation only appears reasonable if one values it on the
basis of 2016 EBITDA (using the already aggressive growth
assumptions we've made in our model).
We will outline a few of the reasons we believe that this name
possesses material downside risks as the existing store base
matures and same-store sales moderate.
(click to enlarge)
There are two buckets of risks which we believe may trigger a
sell-off in the stock price:
-
Fundamental Risks
- Stagnation, Saturation & Imminent Maturation of the
Store Base
- Direct-To-Consumer will Eventually Cannibalize Retail
Store-Based Revenue
- Concept is Unproven in Non-Western Geographies
- Margin Erosion
-
Market Sentiment/Capital Markets-related Risks
- Revenue or Margin Miss
- Short Interests
We will present our model here, which shows our assumptions,
growth drivers, and estimates:
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(click to enlarge)
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FUNDAMENTAL RISKS
(1) a. Stagnation, Saturation & Imminent Maturation
of the Store Base:
Same-store sales (called "comparable store sales" in the
filings) refers to Lululemon stores which have been in operation
for at least 12 months. These are considered 'mature' stores.
Lululemon's same-store sales growth has historically been
exceedingly high - with revenue growth percentages in the double
digits on a year-over-year basis. This is unsustainable.
With Lululemon's sales-per-square-foot already at levels that
are far in excess of other retailers, Same-store sales cannot grow
at double-digit levels indefinitely. We believe that same-store
sales growth will moderate, and will decline to mid-to-high single
digits in 2013, and to mid-single digits in subsequent years.
Management has already recently provided guidance suggesting that
future SSS growth will be in the "high single digits" for the last
quarter of 2012.
Despite the company's global expansion plans, unless there is a
marked escalation in the pace of new store growth, new stores as a
percentage of total stores will decline, which creates a greater
reliance on growth in same-store sales to fuel corporate growth.
Thus, moderating SSS growth will have a more profound influence as
the store base becomes comprised of a larger percentage of mature
stores.
Existing regions, particularly Canada, where Lululemon is fully
penetrated may have reached a saturation point, and new stores are
unlikely to exhibit the same sales-per-square-foot.
(1) b. Direct-To-Consumer will Eventually Cannibalize
Retail Store-Based Revenue
We believe that - supply shortages aside - retailers such as
Lululemon tend to be very demand-driven. While the brand is itself
a differentiator, the reality is that there are a number of viable
substitutes for Lululemon's products.
As such, we believe that the Direct-To-Consumer (online) sales
channel does not generate significant
new
demand for Lululemon products, except where prospective purchasers
reside far from a physical Lululemon retail store. For these
consumers, it would be impractical to visit the bricks-and-mortar
Lululemon store, and thus the direct-to-consumer channel offers
them an attractive alternative and generates sales which would not
otherwise have occurred.
However, particularly with increasing geographic penetration of
Lululemon retail stores, the marginal value of the
direct-to-consumer channel diminishes to the company. As Lululemon
retail stores become ubiquitous, the direct-to-consumer channel
will likely cannibalize retail store sales to a certain extent.
Essentially, we believe that the direct-to-consumer channel is
primarily the refuge of Lululemon customers who live far from
actual stores.
(1) c. Concept is Unproven in Non-Western
Geographies
Brand concepts, even successful ones, can take a considerable
amount of time to gain traction when introduced to new geographies.
There is a material possibility that Lululemon will fail to gain
traction in many of the geographies it seeks to enter as part of
its global expansion, particularly in non-Western nations. At the
very least, it could take longer than expected for the concept to
gain popularity. Unless Lululemon franchises stores in these
jurisdictions, these stores may fail to achieve the same level of
sales-per-store as the Canadian, US and Australian Lululemon
locations.
(1) d. Margin Erosion
Lululemon's gross margin of 55.5% is higher than all of the
comparable companies except for H&M and Inditex (Zara), which
are known to be low-cost branded retailers. We will note that the
fact that H&M and Zara are fashion-oriented clothing retailers
rather than athletics-oriented may distort the gross margin
comparison.
We believe that the prospect of margin erosion presents material
downside risk to Lululemon's share price. Lululemon is sensitive to
margin erosion arising from any of the following risk factors:
- Increasing competition from other retailers offering
competing product lines. Other retailers such as Nike (
NKE
) are interested in the market niche Lululemon has carved for
itself, and are anxious to launch competing lines.
- Different sales mix: if lower margin items comprise a larger
percentage of the company's sales, gross margin will
decline.
- New product lines offered by Lululemon: increased diversity
of Lululemon inventory means more SKUs and this could lead to
more inventory costs and lower margins. This is particularly the
case regarding untested new products which may be less
successful. The bikini products and male-focused products have
not yet caught on to the same extent as female-focused products,
and this could result in discounting and reduced gross
margins.
- Supply chain issues: given the supply hiccup Lululemon
experienced last year, the company may 'hedge' its supply chain
exposure by ensuring redundancies in its supply chains, but this
will have costs associated with it. As well, if there were a
supply chain interruption, the company may incur higher costs to
have the product produced elsewhere from another supplier.
MARKET SENTIMENT RISKS
(2) a. Revenue or Margin Miss
Lululemon's valuation relies heavily on market sentiment and
momentum. We believe same-store sales growth is the critical driver
of market sentiment, and when it moderates, the stock will decline.
On January 14, when management reiterated guidance of "high
single-digit" same-store sales growth, the stock declined over
6%.
Lululemon has a history of outperforming management guidance,
but reiterating guidance below expectations portends slower growth.
Management would lose credibility if they were to repeat guidance
and then surprise to the upside.
If there is a miss on revenue or on a margin, which indicates
future pressure on margins, this could serve as a catalyst upon
which sentiment could turn against the stock. Of the two, slowing
revenue growth is the larger concern, as growth stories are seen as
scalable on the profit level as long as the top-line increases.
Lululemon is a growth story, and to quote a popular reference,
the music doesn't need to stop to have a devastating effect on the
price of the equity. If the music merely
slows
, the stock will lose the sheen of invincibility. We think the
music is slowing now.
(2) b. Short Interest
Like most stocks with a lofty valuation, Lululemon has a massive
short interest. More important than the quantum of the short
interest itself is
who
it comprises. If a prominent shortseller such as Jim Chanos
(Kynikos) or David Einhorn (Greenlight) takes a sizeable short
position and goes on the record explaining why they think the stock
is overvalued, this could serve as a catalyst for a material price
decline.
Company Management
We have no concerns about the quality or integrity of the
management team; Christine Day and the rest of the Lululemon
executive team have shown a remarkable capacity to execute on their
growth plans. A few mishaps aside (including a recent product
shortage), the execution has been impeccable. Moreover, these minor
setbacks are understandable given the challenge of executing a
global growth plan for a successful and well-honed concept. This,
however, does not excuse the valuation.
Conclusion & Valuation
In conclusion, it should be noted that Wall Street analysts have
a dubious record when it comes to volatile and rapidly-growth names
such as Lululemon (and others such as Apple and many commodity
producers). For these volatile names, rising or falling analyst
price targets are often trailing indicators. Analysts are likely to
slash their targets after the price of the stock has already fallen
materially.
Although the comps are trading at 12.0x LTM EBITDA (see comps
below), we assign a premium blended valuation to Lululemon
comprising 13.0x 2012 EBITDA (3 of 4 quarters are already actual,
and the year-end results should be announced shortly), and a 50%
weighting to 2013 forecast EBITDA.
(click to enlarge)
This gets us to our price target of $51.00 per share.
We believe a catalyst will be required to effect a decline, but
investors should build a short position anywhere over $65.00 in the
absence of (1) further double-digit SSS growth or (2) further
indications of global traction of the Lululemon concept.
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Disclosure:
I have no positions in any stocks mentioned, but may initiate a
short position in [[LULU]] over the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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