Sep 4, 2016 - Consumer & E-commerce Analysis ... Total comparable sales, including comparable store sales and direct
September 4, 2016 Mariano R. Viola, PhD Consumer & E‐commerce Analysis (917) 751‐3733
[email protected] www.violaadvisory.com
Lululemon Athletica Inc. (LULU): Sell @ $60.00 Short Thesis: We believe Lululemon is caught between a Rock and a Hard Place at the moment. While Gross Margins have steadily improved, its space has become more crowded, limiting its ability to raise prices. Over the longer term, there is the issue as to whether the Athleisure trend has already peaked, which calls into question the company’s strategy of growing its retail footprint in order to counter slowing store traffic. We believe a tie‐up with Amazon.com, Macy’s and Kohl’s would be a more efficient strategy for growing traffic. We also believe LULU’s brand is limited to a niche market of Yoga enthusiasts and its ability to diversify into other active lifestyle markets will be challenged by competitors like Nike, Adidas and Under Armour who have broader product portfolios, strong brand recognition, a respectable R&D budget, and deeper pockets to sustain several rounds of price cutting, which we see as imminent. TABLE 1: Lululemon 2Q16 Results 2Q16 Results EPS Cons. Result 0.38
3Q16 Guidance
2Q16 Results
EPS Cons. Result Total Rev.
0.38 in‐line 0.42‐0.44
0.44
miss
514.5M
3Q16 Guidance
Cons. Result Total Rev. 515.5M
beat 535‐545M
Cons. Result 542.4M
miss
Source: Lululemon Athletica Inc. and Estimize.com
2Q16 Highlights ‐ Lululemon reported 2Q16 EPS of 38 cents on revenue of $514.5M, roughly in line with analysts’ expectations of 38 cents and $515.47M, respectively ‐ Total comparable sales, including comparable store sales and direct‐to‐consumer sales, rose 4% y/y, or 5% on a constant dollar basis ‐ Provided 3Q EPS outlook in the range of 42‐44 cents, at the low end of analysts’ estimates of 44 cents, on revenue of $535‐545M, with the mid point below estimate of $542.4M ‐ Total comparable sales growth for 3Q16 is seen in the mid‐single digits on a constant dollar basis ‐ Also updated its outlook for fiscal 2016, raising the low end of its normalized EPS view 2 cents to $2.07‐2.15 from $2.05‐2.15 and revising FY16 revenue view to $2.325‐2.35B from $2.305‐2.345B ‐ Reaffirmed FY16 total comparable sales growth view to mid‐single digits on a constant dollar basis
I.
Women’s Fitness: A Key Growth Driver in Athleisurewear
Athleisurewear is a term that describes apparel used for a variety of activities, including workout gear, casual activewear and loungewear. The U.S. athleisure market is estimated at ~$42.2B with Women’s segment ~46.7% (or $19.7B in sales) of the market and Men’s category ~42.2% (or $17.8B in sales). Children’s category is ~11.1% (or $4.7B in sales) of the market (see Figure 1).
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VIOLA ADVISORY, LLC
09/04/16
FIGURE 1: U.S. Athleisure Market (by Gender, $ Billion)
$4.7
A key driver of the athleisure space has been the trend towards a greater interest in physical wellbeing as well as increased participation by women in sports and other fitness activities. In addition, the desire for more casual apparel in the workplace and a preference by women for yoga wear and by children for performance wear has also fueled the growth in the U.S. athleisure market.
Men $17.8
Women
$19.7
Children
Source: Hanes Brands Inc., February 2016
FIGURE 2: U.S. Athleisure Market Growth (by Gender, %) Figure 2 shows the U.S. athleisure market growing faster over the last 3 years with a CAGR of ~12.7% vs. a growth rate of ~11.3% over the past 5 years. In particular, Women’s category has shown the strongest growth with a 3‐year CAGR of ~15.1% in comparison to 3‐year CAGR of Men’s and Kids’ categories of 10.8% and 10.4%, respectively. Source: Hanes Brands Inc., February 2016
Over the last 5 years, dollar value growth in the U.S. athleisure category appears to be coming from both higher average selling prices (ASPs) and higher unit sales. Figure 3 shows the trend in per capita unit growth since 2010. Average units purchased per transaction have grown steadily from 8.2 units in 2011 to around 10.6 units in 2015. FIGURE 3: Per Capita Unit Trend in U.S. Athleisure Market
8.2
8.2
8.4
2010
2011
2012
9.2
9.5
2013
2014
Higher prices have also been a strong driver of top‐line growth for athleisure companies. As activewear companies continue to innovate, they have also been able to raise prices, particularly more prominent brands such as Nike (NKE: Hold), Lululemon (LULU: Sell), Under Armour (UA: Buy) and Adidas (ADDYY: Buy).
10.6
2015
Source: Hanes Brands Inc., February 2016
The No. 1 and No. 2 players in the U.S. activewear space are Nike and Under Armour. These two companies have seen apparel sales grow over the past five years. Nike’s apparel sales in the North America segment have more than doubled, from $2.1B in fiscal 2011 to $4.4B in fiscal 2015. Under Armour’s global apparel sales have increased from $1.1B in 2011 to $2.8B in 2015. Most of the growth has come from the U.S. market. The No. 3 company in the U.S. athleisure market is Hanesbrands (HBI), which had $1.6B in activewear sales in 2015.
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VIOLA ADVISORY, LLC
09/04/16
Lululemon Athletica (LULU) has been one of the main beneficiaries of the athleisure boom. Their community fitness focus and brand campaigns have made it somewhat of a cult name among yoga fitness enthusiasts. LULU’s product offering caters mostly to the premium end of the activewear market. Their vertically integrated model operates ~252 stores in the U.S. and more than four times that number in its home market, Canada. The company derived ~70% of its revenue from the U.S. market in fiscal 2015 and it plans to open more stores in the United States.
II.
Market Saturation and Growing Competition: Is the U.S. Athleisure Market Close to Peaking?
Strong growth in the activewear space over the last few years has attracted more competition, putting downward pressure on ASPs as companies compete to gain share and consumers shop for bargains. Popular chain stores like Gap, L Brands, and Abercrombie & Fitch have launched their own activewear lines. So has sporting goods retailer Dick’s Sporting Goods with its Calia line sponsored by Carrie Underwood and department store Kohl’s partnership with Shay Mitchell. Other major companies providing activewear options include Urban Outfitters, Gildan Activewear, Bebe Stores, and GIII Apparel. Even designers are getting into the athleisure trend. Tory Burch and Derek Lam, in collaboration with the Gap’s Athleta brand, have launched their own activewear lines along with Fabletics, which was founded by actress Kate Hudson. As the space becomes more crowded, the ability to raise prices becomes more difficult as consumers look for better deals and retailers feel the pressure to cut prices in order to grow market share. Figure 4 shows the y/y declines in ASPs for activewear tights and capris, the staple of any athleisure wardrobe. FIGURE 4: Y/Y ASP Declines of Activewear Tights and Capris
1Q15
2Q15
3Q15
4Q15
1Q16
‐8.8%
‐9.0%
‐9.0%
‐1.0%
‐5.6%
Average selling prices dropped 9% in 1Q16 from a year earlier. And with unit growth slowing, that contributed to a 6% decline in the sales of tights and capris sold in 1Q16. To maintain pricing power, companies need to constantly innovate and product differentiation becomes important. Brands such as Nike, Under Armour and Adidas have the brand strength, a broad and diversified product portfolio and the R&D budget to sustain a competitive onslaught. Whether or not Lululemon has the necessary resources to remain competitive, still remains to be seen.
Source: SportsOneSource
III.
Retail Traffic Slowdown – Amazon.com Tie‐up is Better than Brick‐and‐ mortar Build‐out
Retail traffic to brick‐and‐mortar stores has slowed down considerably over the last few quarters and continues to remain a headwind as more apparel purchases as done online. According to NPD Group, online apparel sales made up 17% of the total dollar value sales in the 12 months through February 2015. Online apparel sales grew 19% y/y. That was faster than the growth rate of overall U.S. e‐commerce sales, which rose 14.6% y/y in 2015 and 15.4% y/y in 2014. Consumers prefer to shop online, not only for the convenience, but because online offers tend to be more competitive since e‐retailers save on the fixed costs necessary to operate physical locations.
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VIOLA ADVISORY, LLC
09/04/16
LULU management indicated that traffic continued to be a headwind in 2Q16 and was likely to extend into the next quarter. The company believes that it still has a small retail footprint and has proposed to increase its square footage by an additional 14% versus last year, by adding 43 net new company‐ operated stores this year: 17 new stores in the U.S., one in Canada, one in Australia, four in Europe, three in Asia and 17 Ivivva stores. All in all, there were 379 total stores in 2Q16 versus 336 a year ago. We believe opening more physical locations to counter the falling trend in store traffic is not an efficient strategy for growing sales. LULU’s total comp sales growth for 2Q16 was 5% on a constant dollar basis with a brick‐and‐mortar comp store sales increase of 4% and an e‐commerce comp of 7%. Clearly, on a comp basis, e‐commerce sales outperform physical store sales by 75%. We believe that expanding the digital footprint via a tie‐up with Amazon.com (183M monthly unique visitors, see Figure 5), or forming a Shop‐in‐Shop arrangement with Kohl’s and Macy’s might be a more efficient strategy to grow retail traffic and increase sales. Per the 2Q16 earnings call, LULU already has a similar Shop‐in‐Shop arrangement with Harrod’s department store in London. FIGURE 5: Monthly Unique Visitors (Million) to U.S. Online Retail Sites (as of January 2016) Expanding the digital footprint and working with wholesale partners like Macy’s and Kohl’s has the potential of minimizing overhead costs, which allows for greater leverage on SG&A expenses. LULU can still exert sufficient control over merchandise quality by controlling how much inventory and which products it wants to make available to its wholesale partners. Source: Statista
Moreover, the company can adopt a “Good, Better and Best” Product/Pricing segmentation model that is also currently employed by Nike, Under Armour and Adidas when working with their wholesale partners. LULU can make available those products that it deems “Good or Better” (with low‐ to mid‐tier pricing) to the wholesale channel and retain the “Best” products with the highest premium pricing for its company‐ operated stores. By working with wholesale partners like Amazon.com, Kohl’s and Macy’s, it can also better target the demographic groups that it wants to sell to without the need to open new stores in expensive locations. This enables the company to increase profitability more quickly – something that the Street is keen on seeing since it already factored that assumption into their pricing models.
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VIOLA ADVISORY, LLC
09/04/16
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