LULU - Lululemon

[benhacker]

There was a decent discussion over at the Fool that was started by this question about LULU, but it moved to a more general discussion of correct multiple in the context of understanding normalized earnings.

 

Thread is here:

http://boards.fool.com/lulu-weak-31286195.aspx?sort=whole#31288917

 

The summary (from me at least) is that you can't think of "correct" multiple for LULU until you decide what return characteristics LULU capital will generate.  I think most everyone agrees that LULU is an above average business.  The question is 'How much' above average is it?  My argument (I'm no longer short, so my work on them is not updated) is that they are still earning "too much" excess.

 

So a 20x multiple for a great company like LULU probably makes sense but if their earnings are temporarily heightened because competition hasn't really kicked in in earnest yet, I think you have to worry about declining profits even though the company is good long term.  It's really a question of normalized earnings.

 

I don't have any answers, I've just seen this show too many times before to want to buy a company at 5x book right as executive and competitive issues show up on the horizon.  "only 20-25x" earnings is hardly a selling point for me.

 

Curious to hear the perspective of anyone, especially those who are long...

 

Ben

 

PS - separately I think that this "normalized" earnings issue is really a branch of availability bias.  Sometimes we fall into the trap that as soon as a company makes $X, we think $X is normal, because it happened.  My filter is to always anchor my reasoning back to book value, and try to see if the $X makes sense in the context of the longer term.  If there are adjustments needed to book, or reasons why the business is special (or extra shitty), you need to make those insights.  Some businesses are special, and deserve tremendous premiums to book... most are not IMO.

[Guest Schwab711]

I think this is a great example of an excellent company that can grow earnings tremendously with little additional capital. I'm not endorsing the valuation now or even Summer 2014 (I passed on it then), but I think I made a mistake in my evaluation. I'm not referring to the recent run-up, I think it's just pulling forward future capital appreciation returns.

 

The more woman I talk to between 20-30 about Lululemon then more I'm starting to realize this is a highly desirable high-end/luxury item for folks in that demo. Successful young folks will always strive to own or belong to something that 'the elite' of our society use or do. I think Starbucks is the best example of high-quality (or over priced for most on this board) items that the 'elite' endorse but the average person can also use (at a much higher % of disposable income!). It leads to incredible profits and a lasting demand. I want to own more companies where folks work hard for the opportunity to pay ridiculous margins and feel tremendous satisfaction once they obtain it (basically See's Candy)!

 

I still don't like the company because they don't seem very 'lean' or well run. So with that, I don't think I was wrong to pass but I do think I was wrong on the concept. I'm definitely on the lookout for similar type companies who profit from high-quality, in-demand products that folks strive to own or use and LULU seems to fit this criteria the more I've thought about it. This all fits my mental model of how consumers will spend increases in disposable income (money available beyond necessary costs of living). The rise in disposable income in the US has trended up at an incredible rate for decades. Costs for basic necessities have consistently decreased in real dollars across the board which has led to a greater % of income being spent on discretionary items(thus, higher disposable income - think Apple). I think all developed countries will see larger income disparity due to a plethora of factors and I don't see it as a bad thing at all, so long as the lowest incomes have some stability/protection. This strategy should work worldwide.

 

As a side note, Disney is evolving into an 'elite' company, further improving their amazing moat. I recently read that the average family attending their parks now has nearly $100k/yr in salary (from $90k/yr just a year prior)! Their ability to raise prices annually is extremely rare and shows their pricing-power. I definitely think 'moat' is thrown around way too often, unless you see PR announcing price raises not caused by COG increases then moat/pricing-power probably doesn't exist! My biggest fear was cord-cutters causing a significant revenue drop for ESPN, which may be answered one way or another when numbers for Sling TV (Dish) come out soon. $20/month for ESPN/ESPN2 and a handful of other channels will be the best test of what ESPN is worth as a stand-alone entertainment option.

[kevin4u2]

This is a company that most people do not understand.  Everything I read on seekingalpha clearly demonstrated the average person knows little to nothing about this company, it's brand, it's cult following, nor have they stepped foot inside of a store. 

 

I purchased the company last year.  I was thinking I could easily earn 20% annually for 5 years.  Fortunately the returns came much quicker than that.  I purchased at 20x my estimate of EPS at the time, making this the most expensive company I have ever purchased (by far).  My decision was based on three key facts (as well as a few other) that I felt most investors didn't appreciate.  Here is the rationale. 

 

1) The brand dominates.  There are only two brands that generate higher sales per sq foot in the world.  They are Apple at $6000/sq ft and Tiffany's at $3000/sq ft.  Lululemon is third at $2200/sq ft.  In retail clothing there is no comparison.  A good clothing retailer might do $500-600/sq ft like A&F or Gap.  They crush everyone in retail.  More people should be asking, how do they do that???  Especially in light of point number 2.

 

2) Marketing.  To date the company has spent little to no money on print or TV advertising.  You will see the brand on real housewives and other tv shows but they don't do TV advertising.  They get it for free.  If you read the 10k you will find they prefer "grassroots" marketing, whatever that is.  My understanding is that they partner with local yoga stores to create interest.  People who do yoga are generally fit and attractive, so once they begin wearing the clothes, the referrals and word of mouth begins.  What if they ever pulled the marketing lever?  What would happen to sales?

 

3) International Expansion.  The company is just beginning to open stores in Europe and Asia.  The European market has to be just as large as the US market. That will double the company.  I estimate they can easily grow to 10 billion in sales world wide.  Rarely do you find a company with such a strong brand at the cusp of their international expansion selling so cheap. 

 

4) Most people (in Canada) believe the brand is strong here and not doing very well in the US.  Nothing could be further from the truth.  In the last two years they have doublesd sales in the US, while Canada has barely moved at just over 400 million.  Their sales per sq ft in Canada is higher but this is offset with lower than average in Australia.  And when I say lower than average, I mean twice the "average" clothing retailer.  There is nothing average about this company.

 

5) They are not a yoga company.  The are one of the strongest clothing brands that has ever been created.  The number of people who wear the clothes that don't do yoga has to be 100 to 1.

 

Based on the above info in the 10k, being in a store, and talking to customers, the company was clearly going to survive the negative press that peaked last summer.  A Nike buyout was another possibility.  As my first Munger type of high quality purchase, I still cannot say I am a convert but it was clearly a learning experience.     

[berkshire101]

Girls in yoga pants.  Why complicate things right?  I liked what I saw and made an investment.  Then so sold for a quick profit, darn it!

[ZenaidaMacroura]

I think this is a great example of an excellent company that can grow earnings tremendously with little additional capital. I'm not endorsing the valuation now or even Summer 2014 (I passed on it then), but I think I made a mistake in my evaluation. I'm not referring to the recent run-up, I think it's just pulling forward future capital appreciation returns.

 

The more woman I talk to between 20-30 about Lululemon then more I'm starting to realize this is a highly desirable high-end/luxury item for folks in that demo. Successful young folks will always strive to own or belong to something that 'the elite' of our society use or do. I think Starbucks is the best example of high-quality (or over priced for most on this board) items that the 'elite' endorse but the average person can also use (at a much higher % of disposable income!). It leads to incredible profits and a lasting demand. I want to own more companies where folks work hard for the opportunity to pay ridiculous margins and feel tremendous satisfaction once they obtain it (basically See's Candy)!

 

I still don't like the company because they don't seem very 'lean' or well run. So with that, I don't think I was wrong to pass but I do think I was wrong on the concept. I'm definitely on the lookout for similar type companies who profit from high-quality, in-demand products that folks strive to own or use and LULU seems to fit this criteria the more I've thought about it. This all fits my mental model of how consumers will spend increases in disposable income (money available beyond necessary costs of living). The rise in disposable income in the US has trended up at an incredible rate for decades. Costs for basic necessities have consistently decreased in real dollars across the board which has led to a greater % of income being spent on discretionary items(thus, higher disposable income - think Apple). I think all developed countries will see larger income disparity due to a plethora of factors and I don't see it as a bad thing at all, so long as the lowest incomes have some stability/protection. This strategy should work worldwide.

 

As a side note, Disney is evolving into an 'elite' company, further improving their amazing moat. I recently read that the average family attending their parks now has nearly $100k/yr in salary (from $90k/yr just a year prior)! Their ability to raise prices annually is extremely rare and shows their pricing-power. I definitely think 'moat' is thrown around way too often, unless you see PR announcing price raises not caused by COG increases then moat/pricing-power probably doesn't exist! My biggest fear was cord-cutters causing a significant revenue drop for ESPN, which may be answered one way or another when numbers for Sling TV (Dish) come out soon. $20/month for ESPN/ESPN2 and a handful of other channels will be the best test of what ESPN is worth as a stand-alone entertainment option.

Regarding the disney bit - do you have a source?

[Guest Schwab711]

http://www.orlandosentinel.com/travel/attractions/the-daily-disney/os-disney-tickets-100-20150222-story.html

[Chalk bag]

This is a company that most people do not understand.  Everything I read on seekingalpha clearly demonstrated the average person know little to nothing about this company, it's brand, it's cult following, nor have they stepped foot inside of a store. 

 

I purchased the company last year.  I was thinking I could easily earn 20% annually for 5 years.  Fortunately the returns came much quicker than that.  I purchased at 20x my estimate of EPS at the time, making this the most expensive company I have ever purchased (by far).  My decision was based on three key facts (as well as a few other) that I felt most investors didn't appreciate.  Here is the rationale. 

 

1) The brand dominates.  There are only two brands that generate higher sales per sq foot in the world.  They are Apple at $6000/sq ft and Tiffany's at $3000/sq ft.  Lululemon is third at $2200/sq ft.  In retail clothing there is no comparison.  A good clothing retailer might do $500-600/sq ft like A&F or Gap.  They crush everyone in retail.  More people should be asking, how do they do that???  Especially in light of point number 2.

 

2) Marketing.  To date the company has spent little to no money on print or TV advertising.  You will see the brand on real housewives and other tv shows but they don't do TV advertising.  They get it for free.  If you read the 10k you will find they prefer "grassroots" marketing, whatever that is.  My understanding is that they partner with local yoga stores to create interest.  People who do yoga are generally fit and attractive, so once they begin wearing the clothes, the referrals and word of mouth begins.  What if they ever pulled the marketing lever?  What would happen to sales?

 

3) International Expansion.  The company is just beginning to open stores in Europe and Asia.  The European market has to be just as large as the US market. That will double the company.  I estimate they can easily grow to 10 billion in sales world wide.  Rarely do you find a company with such a strong brand at the cusp of their international expansion selling so cheap. 

 

4) Most people (in Canada) believe the brand is strong here and not doing very well in the US.  Nothing could be further from the truth.  In the last two years they have double sales in the US, while Canada has barely moved at just over 400 million.  Their sales per sq ft in Canada is higher but this is offset with lower than average in Australia.  And when I say lower than average, I mean twice the "average" clothing retailer.  There is nothing average about this company.

 

5) They are not a yoga company.  The are one of the strongest clothing brands that has ever been created.  The number of people who wear the clothes that don't do yoga has to be 100 to 1.

 

Based on the above info in the 10k, being in a store, and talking to customers, the company was clearly going to survive the negative press that peaked last summer.  A Nike buyout was another possibility.  As my first Munger type of high quality purchase, I still cannot say I am a convert but it was clearly a learning experience.   

 

Well said. My PT in 5-7 years is ~$120. Bought at $40 @ 20x and sold some recently. It is by far the most expensive LTM multiple purchase I have made,  It's at "meh" levels now, but I don't plan on selling out any time soon and am willing to sit it out.

There are many heuristic factors that I love about this company. 1 is internet induced physique and image vanity & general health pursuits, 2 is the ease and actual benefit of yoga, and 3 is the Asian & European pursuit of Western lifestyles & image. One of the few names where I cannot ask for better tailwinds.

And here's the confession of my unpopular opinion, I think Chip Wilson's comment about "fat women need not wear" is actually great for the brand image. I will be the 1st to short this company if they begin to sell size 12+ on discount in the front of the store.