Despite the Obvious Transparency, What in Fact is LULU Covering up?

A peek through Lulu –  An anecdotal, fundamental and technical look.

Is LULU truly transparent or are they actually diverging investors’ attention from their dwindling assetts.

 

Annecdotal
Lululemon was one of my first stock purchases. I bought it before I knew what PE meant, before I knew that technical analysis existed, and before I discovered the camaraderie of traders on twitter. I bought it because I loved their clothes. I played sports growing up and have been a part of the fitness industry my entire adult life. I knew fitness clothes and Lulu had opened up a whole new brand of fitness clothes that would completely change women’s expectations for workout gear. I lived in Los Angeles when that first store opened in Santa Monica, CA before anyone in the US knew about their existence. Their clothes were amazing, comfortable, stylish, and attractive (even on not so nice bodies). The material was revolutionary. It quickly dried sweat, felt great, and really took workout wear to a whole new level. It caught on quickly and before I knew it every woman (in Los Angeles) owned some. And no, women weren’t just wearing it to yoga classes. They wore it when shopping at Whole Foods, when out to brunch, when going to get their facial (yes I do realize the brand appealed to a select niche of upper class women). Never-the-less, the product was great, it was popular and the company was surely growing. The one potential downfall I saw for the company during their early stages was that their clothes were made too well. I still have some of my favorite originals that I bought over five years ago and have worn more times than I care to share and they still look good! Yet it hadn’t been a problem for Lulu because they kept innovating and coming out with better, more stylish clothes, and began catering to different niches. I would see someone wearing one of their new lines and I had to have it (and by no means am I one of those girls that likes to shop. I probably have less pairs of shoes than most men).

There were naysayers everywhere shorting the stock and getting their ass handed to them. Most of them were men who kept touting that yoga was just a phase and wouldn’t last so why would yoga clothes. I wanting to slap them and say, it’s not just yoga clothes. In fact, when I started wearing Lulu I don’t think I had ever stepped foot into a yoga room. Non believers would also state that people wouldn’t pay $85 to over $100 for a pair of workout pants. But they were wrong! Even cheap friends of mine would pay up once they had their first pair. They were worth it because there was no other brand that could compare.

The above paragraphs are written in past tense. So that brings us to today where I am no longer bullish about Lulu. I currently live in New York City, which has a very similar demographic to Los Angeles with high fashionable, wealthy women that make fitness a large part of their life. Besides stock trading I teach spin classes at several upper class gyms in Manhattan and am privy to what women are wearing. Here is the scoop. They are still wearing Lululemon; however, they are wearing it less and what many of them are wearing is their old Lululemon clothes. The days of buying a few new outfits every season are over. I believe this is the case for several reasons.

1) Lack of innovation: Just like if you have had the iphone through every cycle, the newest one lacks the excitement you have become accustomed to when getting a new one. Their mens line has never really taken off and so you wonder where the new traffic is going to come from. They have made some headway with their dance line and stated on their recent conference call that they would be introducing both a golf and tennis line. However, I have my doubts as to how successful they will really be. Currently their reliance seems to be on new people (mostly women) in locations they haven’t been present in yet and loyal customers wanting the newest color scheme/design they come out with.

2) They are starting to face competition. I will admit that thus far I have yet to try any other brand that does it like Lulu does; however I am noticing that certain companies are getting close. It’s only a matter of time before another company (or more) finally gets the fit, style and quality just right.

3) The quality of their clothes is starting to suffer. Obviously we already all know about their see through pants, but it goes beyond that. The stitching and wear-ability has gone down hill. Some of my oldest Lulu clothes are actually in better shape than some of my newer purchases.

After reading more about this recent blunder, which took precedence over all other information during their conference call, I think it was a way to diverge attention from their decelerating growth. The “see-through” problem that the company claims started with a new line that came out March 1st is false. The problem started perhaps as early as a year ago. If you look at blogs of Lulu devotees such as LuluAddict, you will see that customers have been complaining about this problem as well as other problems way before March. Also, according to Eclat Textile Co. of Taiwan (a supplier blamed by Lulu for the blunder) the Lululemon pants that it shipped were not “problematic,” (cited by the Wall Street Journal). “All shipments to Lululemon went through a certification process which Lululemon had approved. All the pants were manufactured according to the requirements set out in the contract with Lululemon.” This begs the question, has Lulu been trying to cut corners to keep their profit margins from sagging?

Fundamentals

Here is a some fundamental analysis courtesy of The Oxen Group. You can read their full analysis HERE.

The current PE at 42.9 (38.73 as of today) is much higher than the industry average at 22.7. Its value is indicated to drop according to its future PE of 30.9 (27.71 as of today). Even though LULU saw large percentage increases in revenues, its operating margin and gross margin did not reflect this change. Instead of increasing as well, operating margin decreased YoY from 27.2% to 25.3%. Gross margin decreased during this same period from 57.3% to 55.2%. These slight decreases in profitability margins show us the vulnerability LULU finds itself in while it is overvalued. An overvalued PE and declining problems forecast larger problems to come during the 2013 fiscal year.
Note, same store sales growth also slowed to 10 percent from 26 percent a year earlier. And this slow down is taking place as they are opening new stores.
Technicals 
Weekly and daily charts below. Notes are written on the chart. 
 
 
 
 
My concern with shorting LULU is highlighted well by Seth Golden who writes HERE

It may not be prudent to short a company with an elevated cash position as the threat of a buyback is always looming. Additionally, there are more than 20 million shares held short and at a 12-month high which could, under a short squeeze, prove to propel the stock higher.
Having expressed my bearishness toward Lulu, I will also add that I am currently wearing Lulu as I write this. Furthermore, I intend to wear them predominantly over the near term when I workout and I intend to continue to shop in their stores. However, my purchases will continue to slow down (as they already have) and I will also begin to open myself up more to other brands. 
 
I am currently short Lulu through puts.

3 Enlightened Replies

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  1. Really a great breakdown (and I’m in my LULU leggings, only replaced my 4 year old pair this year and I actually prefer the newer one, softer somehow).
    The Santa Monica store is still quietly, 600.00 armload of five or six things, raking in the customers and the dollars. It’s certainly a weather thing here compared to NY … and yes it is clearly attracting a former Juicy Couture tracksuit kind of customer that wears it constantly (I am off to yoga, promise … ok , and a run to WFM but that’s it!!).

    It did formerly have a fashion sense that is completely lacking now, just same old redone bottoms and no take-your-breath-away jackets and tops for cult people (me).

    I remember the debacle a few years ago when it was discovered there was no bamboo in the textile – it did get past it. I don’t think another company, YET, does it better but there’s certainly going to be one.

    TIF is far dumber, in my opinion, and while beating this past quarter, oh really yawn, tired and against the trend of less logo and recognition.

    Nice piece.

  2. RAEckart says:

    Store expansion plans/numbers could also hurt a short thesis. Good luck!

  3. Addie alexa says:

    I had been searching for some updates in women’s clothing range and i am really happy to see this funny thing on your blog.

    http://www.apparelnbags.com/store/golf-apparel.htm

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