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Lululemon Athletica Inc. - Equity Analysis

Updated: Dec 4, 2023

Highlights



We issue a BUY recommendation on Lululemon Athletica Inc. (LULU) based on a median one-year target price of $430.00, with a high estimate of $531.00, offering a 21.46% upside potential from its closing price of $354.95 on June 8, 2023. Our recommendation is primarily driven by


Macroeconomic Outlook


Consumer spending • The company's performance is tied to consumer spending patterns. During economic downturns or periods of reduced consumer confidence, consumers may cut back on discretionary spending, including purchases of athletic apparel. However, during periods of economic growth and favorable consumer sentiment, Lululemon could benefit from increased spending on its products.


Global economic conditions • Lululemon operates internationally, so it is affected by macroeconomic conditions in different countries. Economic factors such as GDP growth, employment rates, inflation, and exchange rates can impact consumer purchasing power and overall demand for Lululemon's products in different markets.


Competition • Lululemon operates in a competitive industry with both established brands and emerging players. Changes in the competitive landscape, such as new product offerings or pricing strategies from competitors, can impact Lululemon's market share and financial performance.


Supply chain and production cost • Lululemon's profitability can be influenced by factors such as raw material prices, transportation costs, and labor expenses. Fluctuations in commodity prices, changes in trade policies, or disruptions to the supply chain can affect the company's cost structure and profit margins.


Industry trends • Lululemon's performance is also influenced by broader trends in the athletic apparel industry. These may include shifts in consumer preferences, emerging fashion trends, technological advancements, and changes in athleisure and wellness culture. Staying ahead of these trends and adapting to evolving consumer demands are crucial for the company's success.


Brand Diversity • Lululemon is known for its commitment to brand diversity, embracing inclusivity in its offerings. The company recognizes the importance of catering to a wide range of body types, sizes, and athletic abilities. Through its diverse range of products and inclusive marketing campaigns, Lululemon aims to empower and celebrate individuals of all backgrounds, fostering a sense of belonging within the athletic community. By championing diversity, Lululemon continues to build a strong and inclusive brand image.


Growth strategy • Lululemon's growth strategy focuses on expanding its global presence by entering new markets and increasing brand awareness. The company aims to enhance its direct-to-consumer channels, including e-commerce, to reach a broader customer base.


Main risk factors • Disruptions in global supply chains and potential increases in raw material costs could affect the company's production and profitability. Additionally, economic downturns or shifts in consumer spending patterns may impact Lululemon's sales and overall performance.




GENERAL ANALYSIS


Company Description


Lululemon Athletica Inc. is a renowned Canadian company headquartered in Vancouver, British Columbia. It operates in the retail industry, specifically focusing on athletic apparel and accessories. The company has gained significant recognition for its premium quality yoga and activewear.


The origins of Lululemon trace back to 1998 when it was founded by Chip Wilson. Initially, the company started as a small yoga studio and eventually transitioned into designing and manufacturing its own athletic clothing line. Lululemon quickly gained a loyal customer base due to its commitment to producing high-performance and fashion-forward activewear.


Currently, the CEO of Lululemon Athletica Inc. is Calvin McDonald, who has been leading the company since 2018. With his extensive experience in the retail industry, McDonald has focused on expanding Lululemon's global presence and strengthening its market position.

Lululemon operates in the retail and apparel industry, specifically catering to the activewear segment. The company is known for its premium quality fabrics, innovative designs, and functional features, which resonate with fitness enthusiasts and individuals seeking comfortable and stylish workout attire. While yoga remains a core focus, Lululemon has diversified its product offerings to include clothing and accessories for various athletic activities such as running, training, and swimming.


Lululemon has established a prominent market position by emphasizing the fusion of fashion and functionality in its products. The company's attention to detail, quality craftsmanship, and commitment to meeting the needs of its customers have contributed to its success. Lululemon has managed to carve a niche for itself as a luxury athleisure brand, appealing to a wide demographic that values both performance and style in their activewear. Despite some recent attempts of the firm in selling and merchandising and accessories for men and children, like water bottles, mats, sports bags, and more; most of the collections are still targeted for women, making them mostly women-eccentric.



With its extensive retail network, including more than 460 physical stores across North America, Europe, Asia, and Australia, as well as an online platform, Lululemon has a strong global presence. The company has continued to expand its reach and increase market share through strategic partnerships, collaborations, and continuous innovation in its product offerings.


Industry Overview and Competitive Positioning

The SWOT of Lululemon



Strength:

For any company, it is very significant to identify their strength. For a brand like Lululemon Athletica, they have several vital points that have helped them gain their present position in the retail market. They need to strengthen their strong pre-existing issues to keep up their position in the current retail market.

  • Lululemon provides customers with high-quality products with innovative features, which makes them different from most other brands. They consider the community while planning their market strategies and approach, which helps them to grow.

  • The brand has a strong reputation for its brilliant, co-operative staff and good customer care support. They also think about the local customers, which has strengthened their local customer base.

  • Lululemon has a customer-oriented business module that has them to understand and think about their customer base. Their product quality matches customer demand, which makes them one of the popular retailers.

  • Lululemon has an extensive Research and Development department, namely White Space, that continuously works hard to bring innovative features to improve product quality.

Weakness:

  • Every brand has its weak points, and improving them can help them get a better response from the customers. Though Lululemon is a famous brand, they have some arrays to improve.

  • Though Lululemon products are innovative, their products' price is higher than its competitor brands like Nike & Under Armour. The brand’s Yoga accessories have a limited target audience and prevent it from reaching the mass.

  • The brand’s issues with inventory and logistics concern, and this affects their performance.

  • Lululemon needs to work on their marketing. The brand’s online presence is significantly lesser than its competitors, and hence it fails to bring in many customers. For this reason, brand recall is also less for Lululemon.

  • The brand has a limited international presence, which is a drawback that it is holding it behind, while its other competitors like Nike, Adidas, Fila have an extensive reach.



Opportunities:

  • The current retail market is ready to accommodate more brands, which will lead to increased competition. Recognizing the opportunities can help Lululemon expand its business and improve its current position.

  • Lululemon needs to work on its international operations. If the brand can improve its global reach, its business can significantly improve. The retail market in India and China is a good option, and the brand needs to open more physical stores in these two countries.

  • To increase its business, Lululemon needs to consider having some less-expensive products. It will bring in more customers, and the brand will have a strong brand presence.

  • Lululemon’s presence can be improved by extensive marketing, and they can also involve the sports personalities for their campaigns.

  • The brand can have a better reach into the emerging economy. They need to work on their brand awareness for improved sales.


Threats:

  • The post-COVID-19 market is facing a challenge because of the dire economic conditions. Lululemon will also face the consequences while trying to expand their business in the current market scenario.

  • Lululemon is under constant threat as the sports retail market is a rapidly growing market. Other competitive brands like Nike, Amazon, Gap, & Under Armour are also trying to improve their market, and hence Lululemon may face tough competition.

  • While Lululemon will try to expand their business, they can face local government laws and regulations. The controversies in upper management may prevent the company’s growth.

  • Lululemon’s presence can be improved by extensive marketing, and they can also involve the sports personalities for their campaigns.

  • The price-conscious buyers will choose the competitive brands over Lululemon because of their pricey products.

FINANCIAL ANALYSIS


Liquidity

Liquidity refers to the ability of a company to meet its short-term obligations by converting its assets into cash quickly and easily. It represents the company's ability to generate sufficient cash flow to cover its immediate financial needs and is essential for the smooth functioning of its operations. There are several measures commonly used to evaluate liquidity, including the current ratio, quick ratio (also known as the acid-test ratio), and cash ratio. Let's discuss each of them:


  • Current Ratio: The current ratio is a liquidity measure that compares a company's current assets to its current liabilities. It is calculated by dividing current assets by current liabilities. The formula for the current ratio is: Current Ratio = Current Assets / Current Liabilities.

Current assets include cash, marketable securities, accounts receivable, and inventory, while current liabilities include accounts payable, short-term debt, and other obligations due within one year. The current ratio indicates a company's ability to pay off its short-term liabilities using its short-term assets. A higher current ratio generally implies better liquidity, as it suggests the company has more current assets to cover its current obligations.

  • Quick Ratio (Acid-Test Ratio): The quick ratio is a more stringent measure of liquidity than the current ratio. It excludes inventory from current assets since inventory may not be easily converted into cash in the short term. The formula for the quick ratio is: Quick Ratio = (Current Assets - Inventory) / Current Liabilities

By focusing on assets that can be quickly converted into cash, such as cash, marketable securities, and accounts receivable, the quick ratio provides a more conservative assessment of a company's ability to meet its short-term obligations.

  • Cash Ratio: The cash ratio is the most conservative liquidity measure, as it considers only a company's cash and cash equivalents in relation to its current liabilities. It excludes other current assets like accounts receivable and inventory. The formula for the cash ratio is: Cash Ratio = Cash and Cash Equivalents / Current Liabilities

The cash ratio provides insight into the company's immediate cash availability to cover its current liabilities. It indicates the ability to meet obligations even without relying on the conversion of other assets.



Depicting from the graph above indicating Lululemon’s ratios over the past 5 years, there’s clear evidence of a down turning trend. Current ratio has dropped from 2018 to 2019 by more than 2 points: from 4.9 to 2.8. In the last year however, there seems to have been a slight trend reversal or at least a stabilization; the value has increased from 1.8 in 2022 to 2.1. in 2023. Similar trends can be found also in the cash and quick ratios, despite in these ones there’s still no evidence of a changing trend. At the moment the value for the cash ratio is fixed at 0.7 (showing that the firm has more debts than liquid assets) while the quick ratio is even below zero. These are values pretty far from the ideal desirable ones, which should be higher than 1.


If liquidity ratios such as the current ratio, quick ratio, and cash ratio are consistently falling over time, it generally indicates a deteriorating liquidity position for the company. This trend may be evidentiary of an increasing financial risk: falling liquidity ratios suggest that the company may be facing challenges in meeting its short-term obligations. It could indicate a higher risk of defaulting on debts or struggling to pay suppliers and other creditors. This situation can negatively impact the company's creditworthiness and increase its overall financial risk.


A highly likely reason for this trend can also be found in inefficient asset management: declining liquidity ratios may suggest inefficiencies in managing the company's assets. It could indicate issues with inventory management, slower collections of accounts receivable, or a decline in cash reserves. These inefficiencies can tie up funds that could otherwise be used to meet short-term obligations. A consistent decrease in liquidity ratios could even indicate a decline in the company's operating cash flow. If the company is unable to generate sufficient cash from its core business operations to cover its short-term liabilities, it may be facing operational challenges, such as declining sales, increased expenses, or inefficient cost management.


Additionally, falling ratios might indicate that the company is relying heavily on debt financing to meet its short-term obligations. This can lead to increased interest expenses and potential difficulties in servicing the debt. Over time, a high debt burden can strain the company's liquidity position and hinder its financial flexibility. It is worth noting that these ratios can be influenced by external factors such as industry-wide challenges or adverse economic conditions. The recent covid pandemic and the subsequent inflation crisis may have considerably impacted the firm, making it to face difficulties in generating cash flow and maintaining liquidity.

Profitability


Profitability is a measure of a company's ability to generate profits from its operations. It indicates how effectively a company utilizes its resources to generate a return. There are several financial metrics used to assess profitability, four of which are Return on Equity (ROE), Return on Invested Capital (ROIC), net revenues and net profit margins.

  • ROE (Return on Equity) measures the return generated by the company on the equity invested by its shareholders. This ratio is calculated by dividing the company's net income by its shareholder's equity. A higher ROE signifies that the company uses its shareholder's equity effectively to generate profits.

  • ROIC (Return on Invested Capital) measures the return generated by the company on the total capital invested in the business. This ratio is calculated by dividing the company's after-tax operating profit by its invested capital. A higher ROIC indicates that the company uses its total capital efficiently to generate profits.

  • Net revenue is the total amount of revenue earned by the company from its sales or operations, after deducting any deductions such as returns, discounts, and allowances. It represents the top line of the company's income statement and indicates the total amount of money earned by the company before any expenses are deducted.

  • Net profit margin is a financial ratio that measures a company's profitability by calculating the percentage of revenue that is left after deducting all expenses, including taxes and interest. This ratio is calculated by dividing the company's net income by its net revenue. A higher net profit margin



By analyzing these financial metrics, the net total revenues have more than doubled in the period spanning between 2019 and 2022, reaching 975,322$ in that year. In the last here there has registered a slight countertrend and has seen revenues decrease to 854,800$. Projections are anyway bullish and suggest that revenues should increase by a constant 13% over the next 5 years. The net profit margin has followed a different trend, with peaks and dumps over the period of analysis. The net profit margin in 2023 of 10.54% saw a significant increase with respect to the previous year, scoring the lowest value of the period.


Both ROE and ROIC experienced a similar trend with a consistent reduction of the values in the period between 2021 and 2022, then countered by new signs of growth during the last two years. This trend has surely been affected by the covid-pandemic but this firm into the specific doesn’t seems to have encountered major crisis periods.


In 2023 Return on Equity was 42.32%, an incredibly high value indicating that the company is generating substantial profits and returns relative to its invested capital. An ROE greater than 40% suggests that the company is effectively utilizing the equity capital provided by its shareholders to generate significant revenues. It also indicates a high level of efficiency and profitability in utilizing shareholder investments.


From the data of January 2023, also ROIC value was pretty high, around 29.19%. This digit shows that the company is generating substantial returns from all sources of invested capital, suggesting the efficiency in utilizing both equity and debt funds to generate profits, while at the same time reflecting effective capital allocation and operational efficiency.


Generally having both ROE and ROIC greater than or equal to 30% is generally considered a positive sign for a company. It suggests that the company has strong profitability, efficient utilization of capital, and effective management of both equity and debt investments.



Stock Valuation


Discounted Cash Flow Analysis


The Discounted Cash Flow model is a popular valuation technique used to estimate the intrinsic value of a company. This model utilizes future cash flows, discounted to their present value, to determine the present value of a company's assets. It is based on the concept that the intrinsic value of an investment is the present value of its expected future cash flows. This approach is widely used in financial analysis and investment valuation, as it takes into account the timing and risk of future cash flows. It provides a quantitative approach to estimate the fair value of an investment based on its expected cash flows, enabling investors to make informed decisions about the relative attractiveness of different investment opportunities.



To calculate the present value of a company using the DCF model, I have forecasted future cash flows for Exor, taking into account factors such as revenue growth, operating expenses, capital expenditures, and taxes. These forecasts were then discounted back to their present value using the company's weighted average cost of capital (WACC). This is a financial metric that measures the average cost of capital for a company. It is a calculation that takes into account the cost of both equity and debt capital, weighted by their respective proportions in the company's capital structure. For our analysis of Lululemon, we found the WACC to be around 1.5%. It is however important to notice that this measure relies on several assumptions and specific circumstances; particularly, by changing beta and the market risk premium assumptions, the WACC value can change considerably. A WACC of 11% suggests that, on average, the company needs to generate a return of 11% on its investments to cover the cost of capital and meet the expectations of its investors. It serves as a benchmark for evaluating the attractiveness of investment projects or assessing the company's overall financial performance.


In the discounted Cash Flow Analysis the base case for the formulation of the intrinsic value of the company were data from historical performance and industry outlook. The model is forecasted five years, mainly because the industry of home fitness equipment is considered to be in its mature phase, which allows for more predictability of the company ́s Free Cash Flows.



Once the cash flow projections are in place, each future cash flow is discounted to its present value. This is done by dividing each cash flow by a discount factor, which represents the time value of money. The discount factor is derived from the discount rate and the time period. The formula to calculate the present value of a cash flow is:


Present Value = Cash Flow / (1 + Discount Rate)^n


Where n is the number of periods in the future when the cash flow will be received.


Since cash flow projections are typically made for a finite period, a terminal value is calculated to capture the value of the investment beyond that period. The terminal value represents the value of the investment at the end of the projection period. There are different methods to calculate the terminal value, such as using a multiple of a terminal cash flow or employing a perpetual growth rate. The next step involves summing the discounted cash flows from the projected periods and the terminal value to determine the total present value of the investment. This summation represents the estimated intrinsic value of the investment. The final step is to compare the calculated present value of the cash flows with the current market value of the investment or company. If the calculated present value is higher than the market value, the investment may be considered undervalued, indicating a potential opportunity. Conversely, if the calculated present value is lower than the market value, the investment may be considered overvalued.


DCF analysis provides a systematic framework for evaluating the attractiveness of an investment opportunity or assessing the fair value of a company. However, it is important to note that DCF analysis relies on assumptions and projections, and its accuracy depends on the quality of those inputs. Therefore, it requires careful consideration of factors such as the reliability of cash flow projections, the appropriateness of the discount rate, and the validity of the terminal value estimation. The model is forecasted five years, mainly because the industry of home fitness equipment is considered to be in its mature phase, which allows for more predictability of the company ́s Free Cash Flows.






Multiples Analysis


For this analysis, we used two fundamental multiples commonly used by investors and analysts to evaluate a company's financial performance and make investment decisions. Revenue-based multiples are particularly useful for cross-country comparisons. The EV/EBITDA ratio is a financial metric used to estimate the value of a company in relation to its EBITDA. It is computed by dividing a company's Enterprise Value (EV) by its EBITDA. Enterprise Value represents the market value of a company's equity and total debt, excluding cash and cash equivalents. On the other hand, the Price-to-Earnings (PE) ratio measures a company's current stock price in relation to its earnings per share (EPS). It is obtained by dividing the current market price per share by the EPS. This widely used valuation metric helps determine whether a company's stock is overvalued or undervalued relative to its earnings. A higher PE ratio typically suggests that investors are willing to pay more for each dollar of earnings generated by the company, while a lower PE ratio may indicate that the stock is undervalued. Excluding the anomalous 2020 year, the P/E ratio for the financial sector has consistently remained below its average, with values of 8.3 and 5.4 in 2018 and 2019, respectively. However, in 2021, the P/E ratio for the sector was around 6, while the P/E ratio for the stock was 9.9, indicating that the stock may be overvalued. It is also worthwhile to examine the P/CF ratio, which provides insight into the company's ability to manage future cash difficulties. In 2021, the P/CF value of 19 is quite high, with values under 10 generally considered favorable, while values over 10 may imply that the company's price is high or its cash flow is low. It is worth noting that this metric is particularly relevant for industrial companies, and Exor's P/CF value above 10 is not a cause for significant concern. The EV/EBITDA ratio has increased in recent years, particularly after the spread of COVID-19, rising from 4.5 in the previous three years to 16.9 in 2021. An increasing EV/EBITDA ratio may indicate that the market's perception of the company has shifted, resulting in a decrease in the company's valuation. This shift could be due to various factors, such as heightened competition, changes in consumer behavior, or adverse news events. It is important to note, however, that a rising EV/EBITDA ratio does not necessarily imply that the company is performing poorly. For instance, if a firm is investing heavily in R&D or expanding into new markets, it may have a higher EV/EBITDA ratio due to increased debt or lower EBITDA. Nonetheless, these investments could generate long-term benefits and lead to future growth.






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