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We've all been there. You watch a stock, patiently waiting for a dip in price only to see it climb to new heights. Don't kick yourself just yet. If you choose wisely, paying more upfront for a company (especially one with a strong brand) can lead to substantial returns later.
Sometimes, understanding a company's culture is just as important as reading its SEC filings. Such is the case for lululemon athletica (Nasdaq: LULU ) . The yoga-inspired apparel company is not your typical corporate retailer, nor is it your average retail stock. Shares of lulu are up more than 40% this year, which has some investors wondering whether it's already peaked. With its sky-high valuation, is it too late to get into this growth play? Before we jump to conclusions, let's dig into the facts.
The strength of cult branding
lululemon's distinctive corporate culture has earned it the most fashionable accessory in retail: a cult following. That's a remarkable achievement for a company that relies on grassroots marketing. All 165 lululemon stores offer complimentary yoga and fitness classes to the local communities. I've attended a few of these sessions, and within seconds of the end of the free class, participants are trying on clothes and lining up at the register.
In addition to getting customers through its doors, the free classes are led by lululemon ambassadors who, in exchange, get 15% off the merchandise. That's a small price for the company to pay, considering these so-called ambassadors are fitness leaders including Olympians, gym owners, fitness coaches, and yoga instructors who teach classes and train exclusively in lululemon gear.
The kicker: lululemon doesn't pay these athletes to publicly endorse its brand. For emphasis, consider rival athletic-apparel company Under Armour (NYSE: UA ) and sporting-goods behemoth Nike -- both brands fund their success through multimillion-dollar annual endorsement deals for celebrity athletes. In 1984, Nike paid a young Michael Jordan a half-million dollars to wear Nike shoes, a crazy high price at the time.
The success of Nike and Under Armour demonstrates that huge celebrity endorsements work. lululemon's decision to ignore this proven strategy was a huge risk that paid off for the yoga lifestyle brand. Shares of the retailer are up 568% since its IPO in 2007.
Will the success continue?
Unlike Nike or Under Armour, lulu products aren't widely available. Visit your local Dick's Sporting Goods store, and you'll find a seemingly endless supply of Nike and UA gear, often on the clearance racks. What you won't find is lululemon clothing. Instead, small boutique stores carefully designed with the local community in mind are more lululemon's style.
This vertical retail strategy is a home run for the company: Staying out of department stores boosts margins and helps solidify its position as an elite athletic brand. See for yourself how lulu's profit margin stacks up to the competition:
Think of profit margin as the amount of profit lululemon keeps per dollar of revenue. Therefore, lululemon's profit margin of 16.85% (let's call it 17%), means lululemon keeps $0.17 of every dollar earned. That's more than double Nike and Under Armour, which both come in around $0.08 of profit on the dollar.
Another telling metric for retailers is sales per square foot. Last year, lululemon had $1,731 in retail sales per square foot, which was the fourth highest in the U.S. behind Coach's (NYSE: COH ) $1,820, Tiffany's (NYSE: TIF ) $2,974 and Apple's $5,626.
What do the top four retailers have in common? They're all well-known brands that sell high-end products. But where lululemon falls short is a major international presence. Technically, selling in the U.S. is "going international" for the Vancouver-based retailer, but with the U.S. and Canada as its only two real markets currently, it still has a long way to go. Tiffany generates half of its annual revenue outside the United States. Meanwhile, Japan accounted for 18.2% of Coach's revenue last year. Fortunately, lulu sees the opportunity and is meeting it head-on.
lululemon currently operates 165 stores throughout Canada, United States, and Australia. For the third quarter of fiscal 2011, only 4% of the company's net revenue was generated from sales outside North America. That means there's a major growth opportunity. The company's global growth strategy includes expanding its stores into major cities around the world. It's continuing to build the brand's presence in Hong Kong later this year, in addition to adding a showroom in London.
Men's clothing is also a growing business segment for lululemon, as it currently accounts for 15% of revenue. On top of active menswear, the retailer launched a dance-apparel line for teen girls called ivivva athletica, which should further diversify lululemon's revenue channels. The company's position as a lifestyle brand will help power its growth going forward, because customers view the brand as something greater than a mere product.
A worthy investment
In my lululemon-wearing opinion, this growth story is just getting started. The company's real worth is its brand equity. It sells more than just marked-up yoga pants -- it's selling a lifestyle. This strong corporate culture will continue to drive sales and create demand for the product as lululemon opens new locations around the world. I believe the stock price will only become more expensive as its story unfolds. For these reasons, I'm giving lululemon a three-year outperform rating on my profile in Motley Fool CAPS.
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