- Lululemon Athletica (NASDAQ:LULU) fell 15% on March 21, 2024 after guidance for the current quarter came in below the consensus expectation of analysts. In this article, I wanted to deep dive the key reasons for the big drop and why I’m still holding onto LULU.
Financial Performance for Q4 and Full Year 2023
- Q4 Revenue Increase: 16% increase, with a notable rise across all channels, regions, and product categories, signalling strong demand and market presence.
- Americas Revenue: Increased by 9%, indicating steady growth in the company’s largest market.
- China Mainland Revenue: Surged by 78%, highlighting exceptional growth potential and market penetration in Asia.
- Rest of the World Revenue: Grew by 36%, showcasing expanding international appeal.
- Product Category Growth: Women’s category grew by 13%, men’s by 15%, and accessories by 40%, indicating balanced growth across the board.
- Earnings Per Share (EPS): $5.29, compared to adjusted EPS of $4.40 in Q4 last year, representing significant profitability improvement.
Full Year 2023 Results
- Annual Revenue: Reached $9.6 billion, a 19% increase from the previous year, showcasing strong year-over-year growth.
- Adjusted Operating Margin: Increased by 110 basis points, indicating improved operational efficiency.
- Adjusted EPS Growth: 27% increase from 2022, highlighting strong earnings growth.
- Membership Growth: The program grew to more than 17 million members in its first year, showing effective customer engagement and potential for lifetime value enhancement.
Guidance for 2024
- Revenue Expectations: Projected to be in the range of $10.7 billion to $10.8 billion, vs. $11.0B consensus
- Store Openings: Planning for 35 to 40 new company-operated stores, emphasizing ongoing physical retail expansion, especially in international markets.
- Gross Margin: Expected to be approximately flat compared to 2023, indicating stability in profitability despite investments and potential cost pressures.
- Earnings: Full-year EPS of $14.00 to $15.20 is anticipated vs. $14.26 consensus
So Why a 15% Drop?
There’s a noticeable slowdown in consumer behavior in the U.S. market, and the concern is that is a leading indicator to continued slowdowns in the rest of the world
- Management acknowledged a shift in consumer behavior in the U.S., indicating a softer start to the year in this market. This was attributed to a broader retail environment challenge, with U.S. consumers showing signs of cautious spending
- Specifically, management noted that while traffic in U.S. stores was still positive, there was a slight decline in conversion rates. This was partly attributed to product-related issues, such as insufficient inventory in popular sizes (notably, women’s sizes 0 to 4) and a lack of color variety in the offerings
- Management’s response suggested that the slowdown was fairly broad-based, with certain product opportunities identified for improvement
- The 9% growth is a significant measure since the US market represents over 80% of Lululemon’s total revenue
- A significant risk here is that with a low double digit growth, the risk comes with ratio contractions. P/S has been elevated the past 5 years, given that Lululemon was priced as a hyper growth company; as it should as it was growing 20%+ year over year
- A low double digit growth might drop P/S back to the 2014-2017 levels at around 4/share, which represents a potential 20% contraction if the trend continues
Our Thoughts
#1: “China Mainland increased 78% and the rest of the world increased 36%“
- We love diversification and we like the fact that Lululemon’s experiencing strong growth in the rest of the world and diversifying away from just sales in the US market. The growth proves that Lululemon has been executing correctly in the international markets and the product and brand is well received beyond the US market
- To colour in more of the diversification benefit: This strategy can lead to increased brand recognition and customer base growth globally. Additionally, it provides opportunities to capitalize on regional trends and preferences, potentially leading to higher overall sales and profit margins. Moreover, global diversification can offer a buffer against economic downturns in any one region, stabilizing the company’s financial performance
#2: Slowing down of the US market for goods like Lululemon is attributed to the broad market, rather than a significant downturn in demand or consumer interest for the brand
- Nike as a comparison has also been impacted macroeconomic headwinds facing many companies. Rising input costs, stemming from high inflation in recent years and lingering supply chain disruptions, have squeezed profit margins
- The January 2024 data show a small increase in dollar spending but a tiny decline in inflation-adjusted expenditures. In 2023 consumers increased their total spending by 5.9% (December 2022 through December 2023). After inflation adjustment the gain was still 3.2%. Household incomes continued to rise over the course of 2023 thanks to rising employment along with ongoing wage increases.
- Based on a McKinsey study in Feb 2024, US consumers expressed a more positive outlook on the economy in February compared with the previous quarter. One of the key findings below is that there’s a net positive intent to spend more on Fitness and Wellness in Q1 24 vs Q4 23.
- In addition, Forty percent of consumers expressed an intent to splurge over the next three months, which represents a two-percentage-point increase from the end of 2023
In Conclusion
- The recent 15% drop in Lululemon’s stock after the announcement of its guidance for the current quarter falling below consensus expectations might seem alarming at first glance. However, a deeper analysis reveals several reasons to remain optimistic and maintain investment in the company. Here are the key points supporting continued investment:
- Cyclical Nature of the US Slowdown: The observed slowdown in the U.S. market appears to be more cyclical than structural. This is evidenced by significant revenue growth across all channels, regions, and product categories in Q4 2023 and the full year. With household incomes rising and employment and wage increases contributing to increased spending, the downturn could be temporary, suggesting a potential rebound as macroeconomic conditions improve.
- Strong Diversification in International Markets: Lululemon’s impressive growth in international markets, especially the 78% surge in China Mainland and 36% growth in the rest of the world, highlights the company’s successful diversification strategy.
- Continued Consumer Interest in Fitness and Wellness: Despite the current market dynamics, consumer interest in fitness and wellness remains high.
- Strong Financial Performance and Growth Trajectory: Lululemon’s financial performance in Q4 and the full year 2023, with significant increases in revenue, adjusted operating margin, and EPS, indicates a strong growth trajectory.
- Read our investment thesis on Lululemon here to see the reasons why we invested in Lululemon in the first place