Fitness Brand Lifts Outlook Again After Growing By 20% For More Than 10 Quarters

lululemon

It is not very often that a company posts double digit revenue growth.

Among a set of 5,000 publicly listed companies, only 13% were able to generate more than 10% revenue growth between 2009 and 2019.

Basic arithmetic suggests that each quarter of revenue expansion pushes the bar higher, making subsequent growth of the same magnitude far more difficult.

Enter Lululemon Athletica (NASDAQ: LULU), or Lululemon, the activewear company that turns the inconceivable into a reality.

We delve deeper into how this company managed to increase its topline by over 20% for each of the past ten quarters.

Business overview

Lululemon sells fitness apparel, footwear, and accessories under its house brand.

The company targets predominantly females in the North American market, selling its products through a mix of company-operated stores and ecommerce, among other retail arrangements.

Despite consistent revenue improvements every quarter, the activewear retailer is still subjected to seasonality as the fourth quarter tends to be the strongest, coinciding with the holiday season.

Thus, the company operates in the consumer discretionary segment based on its price point which is tied to the consumption patterns of its customers.

Since pre-COVID times, Lululemon’s gross margin has consistently been over 55%, with its earnings before interest, tax, depreciation and amortisation (EBITDA) margin being subjected to more fluctuation around mid-20%.

Taken together with a steadily climbing revenue, the business looks to be fairly profitable.

This is reinforced as the company lifted its 2023 outlook above what was previously guided.

Lululemon bucks consumption patterns

Interestingly, the strong consumer support at Lululemon appears to run contrary to various purchasing trends.

For instance, spending trended downwards for both low and high-income groups, with the difference between the two narrowing recently.

The same decline was also witnessed when comparing Gen Z and millennials against baby boomers.

In terms of category, even though apparel ranks among the top four areas that US consumers intend to spend on, fitness comes in second last at 19%.

Furthermore, personal consumption expenditure recovery since the first quarter of 2020 (which is when the World Health Organisation declared COVID-19 to be a pandemic) is stronger for men and boys spending on clothing than that in the ladies.

The compound annual growth rate for male clothing came in at 12.1% versus 11.1% for female clothing.

Considering how Lululemon targets younger women who can afford premium products, the above observations imply multiple headwinds for the athletic brand.

Yet, the yoga apparel manufacturer continues to register robust growth.

Growth strategy rests on three pillars

The secret sauce lies in what management calls the “Power of Three x2” plan which involves three key pillars.

The first of three pillars is product innovation, which according to industry veterans, is typically associated with higher-value, brick-and-mortar retailers that differentiate themselves from cheaper, value-driven alternatives.

Innovation has also enabled the brand to continue to milk its more mature segment – women’s bottoms – while simultaneously extending the reach to monetise new customers such as men.

The second pillar relates to its mode of distribution.

Lululemon uses comparable store sales and direct to consumer (DTC) net revenue to measure the performance derived from existing physical stores and ecommerce or other channels, respectively.

Even after the lifting of COVID-19 restrictions, DTC net revenue increased at a faster pace than comparable store sales.

Indeed, consumers demonstrated the highest willingness to purchase clothing and accessories DTC as compared to other product categories.

Recovery of online shopping practices also explains why Lululemon’s DTC net revenue accelerated faster.

Fortunately for Lululemon, DTC is also more profitable than selling its wares via company-operated stores.

A faster-growing, more lucrative segment should therefore bode well for the athletic brand.

Nonetheless, the company will continue to open new stores going forward as they play an integral role in maintaining brand awareness.

This strategy is, in turn, linked to the final pillar of its Power of Three x2 plan – market expansion.

New stores enable community engagement and convey brand experience, which ultimately help to increase revenue streams internationally.

Diversifying beyond its core North American market is arguably a key lever for the company to sustain its impressive record.

International revenue growth of 60% far exceeds that of North America’s 17%.

Chief executive Calvin McDonald also mentioned that tapping on other markets represents the next phase of growth for the brand.

Fundamentals command premium valuation

Granted, the company’s prospects look great but how does it stack up against other athletic apparel brands?

Lululemon listed a few competitors such as Nike (NYSE: NKE), Under Armour (NYSE: UAA), and Urban Outfitters (NASDAQ: URBN), among others.

On the profitability front, Lululemon is clearly ahead of the pack as it has the highest margins among all its competitors.

Paired with a rapidly rising revenue, this spells good news for Lululemon.

Not only is the company more profitable than its competitors, but its growth also far outstrips the median and average rate in terms of revenue, EBITDA, and net income.

Investors may also be concerned with how richly valued a company is relative to its peers.

As a rule of thumb, higher trading multiples should be underpinned by higher growth rates.

It should therefore not come as a surprise that Lululemon is trading at a premium compared with its peers, with its Enterprise Value (EV)/Revenue, EV/EBITDA and price-to-earnings (P/E) multiples substantially higher than the rest.

It is, therefore, up to investors to determine whether superior growth and margins justify this higher valuation.

As the Oracle of Omaha Warren Buffett puts it, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

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Disclosure: Tan Ke Xuan does not own shares in any of the companies mentioned.

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