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Lululemon's earnings get a boost from China

Lululemon's first quarter results were better than analysts were expecting, thanks in part to strong sales in China. Brian Jacobsen of Annex Wealth Management and Max Kettner of HSBC discuss the impact of China's reopening on the global economy.

Video transcript

- We do want to switch gears, though, and we've got to talk about a stock that is moving off of it's earnings. Lululemon, surging in pre-market trade and it's an international growth story here. Revenue in China surged almost 80% on the year. This time last year was a very different story in the nation of course, there with COVID zero policies still in place.

However, take a look at the shares pre-market, they're up 16%. And some of the key areas China included. But then additionally, if you were to look through what they-- or listen listening to what they talked about over the course of the earnings report, there are a few things that I was hoping they would say more about. Of course, this is a company that has done so well in changing the way that athleisure companies have gone more direct to consumer, but they're also trying to enhance the product mix that they do have.

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Footwear, one of those categories that I looked into a little bit more really only had kind of five mentions word basis on the call. But I think that strategy is what investors want to hear more about going forward as well, considering that it can be very difficult to take on market share. But if they are able to do so successfully, whether that be brick and mortar or whether that be online sales, I think that's where investors can perhaps hang their hat on some of that future growth coming through at Lululemon.

And then additionally, it's just a regional story as well that we witnessed in the most recent quarter. But going forward, what does the US consumer, an area where Lululemon has really hung its hat for so long, what does that consumer hold given some of the discretionary spending that we've seen waver moderate or even dry up in some income brackets as we had heard from other retailers over the course of this earnings season?

- It's not happening with them. I mean, the China sales were undeniably strong, up 79%. They have 101 stores now and now. They're planning to open more this year of those China stores as well. They're opening a bunch of international stores and they said most of them are going to be in China. I think 30 to 35 international stores is what they're talking about here.

But guess what? The US numbers weren't bad, right? The company said comp stores were up 16% in their stores, 18% in the e-commerce business. North America, overall, was up 17%. This struck me as well, women sales up 22%, men sales up 17%, accessories up 67%.

- So those belt bags.

- I assume it's the belt bags, right? I don't know if footwear falls into the accessory category, I would think so. And that's a higher ticket accessory item than a belt bag, for example. They sell lots of other stuff. I have a Lululemon backpack, I got a Lululemon yoga mat. So there are those other things that they're spe-- but that's striking to me that the growth in particular in accessories I thought was quite interesting. So obviously, the market, greeting all of this very enthusiastically and emphasizing the China sales in particular.

- They've got a really solid flip-flop, I'll say that anecdotally. I tried that out.

- I don't know anything about that.

- I tried it on in multiple stores. I still haven't purchased just yet, I've been looking for my size. However, the men's flip-flop feels very good. I just wish that we'd see more of the footwear categories start to move forward. Perhaps we will over at Lululemon.

- One more quick note here is what we saw in inventory. Inventory still was higher by I think something like 24% year over year, which is a slowdown in the inventory increase, but they still talked a little bit about the promotions that are still happening. So that's just something to keep an eye on as we go forward. The so-called we made too much category is Lululemon's euphemism--

- For favorite rack

- --for sale.

- Yeah.

- Of course.

- And it looks like they do break out footwear separately aside from accessories.

- Oh, interesting. So that wasn't the same increase, OK. Let's focus in on the China portion of this for a moment because Lululemon bucking a difficult backdrop for retailers, thanks in part to the strong numbers out of China. But data out of that economy has been mixed to say the least. Let's get back to Brian Jacobsen, Annex Wealth Management chief economist and strategist and Max Kettner, HSBC chief multi-asset strategist. I hope both of you are wearing Lululemon on your lower halves, we'll never know.

But let's talk about China for a moment and how this relates to China. It's surprising to see these numbers. Yes, you've got the year over year comparison when things were more shut down. But still, it's quite interesting to see this sort of reflection of what's going on here. Brian, I'll start with you here. How are you thinking about the China story at this point?

BRIAN JACOBSEN: Some of the data lately has been somewhat disappointing, but I think it just depends upon how enthusiastic you were about what 2023 would look like. We were anticipating that we'd see about 5% GDP growth, which is in line with what the government basically told people that it should be. And it seems like that's pretty consistent with the story.

Now, we have seen some of that weakness in manufacturing. If you look at the services index, that's been good. Yes, it is weakening a little bit. But so far, we think that it's actually the China reopening story, it wasn't bound to be like the reopening in the United States. We thought that it was going to be more almost like this kind of slow boil where things begin to improve as opposed to just this raging fire of demand that suddenly was unleashed. So we're actually still pretty optimistic about this recovery continuing, it's just that it's not going to be as dramatic or as sudden.

Now, it was encouraging to hear a company like Lululemon talk about what things look like in China because everybody I think has been thinking things are slowing too quickly, but maybe there's still a lot of pent up demand there, especially for US producers of global brands. We think that this is actually one of our themes that we like. US companies can really benefit from either asynchronous slowdown that might happen or our base case is more this asynchronous recovery.

- Max, do you believe that there's any type of carry over then for other athletic apparel and footwear companies? I'm looking at Nike shares this morning pre-market, they're up by about 3.25%. So is what's true for Lululemon in an international market also true for some of the same players within that industry?

MAX KETTNER: Yeah, I think so. If we look at consumer discretionary more broadly and outside of the more techie and growth sensitive names and the consumer discretionary categories. In fact, when we look at some of our analysis that we do around earnings, calls, and around earnings call sentiment, particularly with regard to the guidance of those consumer discretionary companies. And really, what we're seeing is that particularly after the Q1 reporting season, guidance of these consumer discretionary companies has been as strong as it has been for three years, so just before COVID.

So in reality really, I think consumer demand still remains pretty healthy. Nominal growth, which at the end of the day for us as investors is the most important, right? We don't really care whether real GDP growth will be going up by 0.2 or down by 0.2 as long as nominal growth is on pretty healthy levels, and that is supporting nominal earnings quite well. That actually is pretty good. And I think that particularly applies to consumers as well.

And perhaps one word on China I would agree with what Brian is saying, we look at the consensus forecasts for this year for GDP than when you look at the major global economies, the eurozone, the US. And what we've seen has been very tepid upgrades to growth forecasts, to those group of consensus growth forecasts. All that's really been happening is that consensus has dropped the full year recession calls.

But when we look at China, people have become much more optimistic and really much more sort of enthusiastic about the near term growth rebound. So whilst the story isn't wrong, perhaps the market and consensus has become a little bit ahead of themselves and now we're starting to see a bit more reality. But I would say, particularly in China, the domestic consumption story still remains very much intact.

- And so just briefly from both of you, by Chinese stocks here, we had I think some strategists cut their recommendations on it this morning. Brian, you first.

BRIAN JACOBSEN: Yeah, the way that we're looking at it at Annex is we prefer to take a more diversified approach to investing in emerging markets. Maybe think more about the longer term themes, about the reshoring, who's going to be the beneficiaries there? It could be companies in India, Vietnam, Mexico, other places outside of China. But we do still have a positive outlook on the Chinese consumer, so it really does depend upon the sector and the specific companies.

- And Max.

MAX KETTNER: Yeah, I think probably broadly speaking, if we look at Chinese indices, they're too geared still towards the old economy, towards manufacturing. So it's much more a stock picker's market. It's what Brian was saying, the longer term thing is particularly around the Chinese consumer really looking at some of those sectors and in particularly, stocks that benefit from that the most.

And otherwise, we're seeing a bit more perhaps attractive opportunities elsewhere in places like Mexico and LATAM, in places like India and the GCC, for example, or perhaps there's a bit better opportunities tactically right now from a broader market index perspective.