Can lululemon Sustain Its Competitive Advantage?

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If health is wealth, then lululemon athletica's (Nasdaq: LULU  ) fitness-focused approach to retail is a winning bet. Lululemon is an athletic apparel company that's making its mark on the world one yoga mat at a time. The Canadian company is sinking the competition by connecting with its customer base through community outreach and brand loyalty. But can strong branding keep rivals at bay in the long run?

A trend with staying power
Even after a recent drop in its stock price, Lululemon has still nearly tripled since going public in 2007 at $18 a share, and continues to generate above-average profits compared to competitors. Today, Lululemon's products are sold online and in 147 company-owned stores and four franchised stores in Canada, the United States, and Australia.

The retailer also came up strong in same-store sales in its second quarter, rising 20% on a constant dollar basis. Still, many investors doubt Lululemon's stock can live up to its hefty valuation.

Competition from both Nike (NYSE: NKE  ) and Gap (NYSE: GPS  ) has analysts worried that Lululemon will struggle to expand market share. The company has consistently beaten revenue and earnings estimates for the past five quarters. However, investors aren't yet convinced it can keep up its impressive run. Of course, smart management and a durable competitive advantage can be a winning combination.

Playing the trump card
After starting a trend, Lululemon held all the aces in developing superior products and strong community-centric branding. As a Lululemon addict myself, I can attest to the quality and superiority of its products.

I'm a fan of the fabrics used in Lululemon's clothing, including quality materials like Luon and Silverescent. They offer a WetDry feature that pulls moisture away from your skin, spreading it evenly throughout the fabric so that the garment dries in record time.

As I've seen firsthand, the quality of Lululemon's products is simply unmatched. With the cost of that quality already built into its business model, it demonstrates the tremendous pricing power of its products.

How fitting
Lululemon has another important advantage over the competition: its position as a lifestyle brand. Similar to Apple (Nasdaq: AAPL  ) , Lululemon has legions of loyal customers that view the brand as something greater than a mere product.

The company continues to generate impressive sales growth and at a fraction of the cost of what industry peers have paid to promote their brands. Both Under Armour (NYSE: UA  ) and Lululemon have enjoyed rapid growth this year -- but the difference is that Under Armour dished out tens of millions of dollars in endorsement deals with professional athletes and product placements to get it. Under Armour's marketing costs increased $6.7 million from the year-ago period to $34.1 million for the three months ending on June 30, 2011, primarily due to athletic sponsorships.

You might be surprised to learn that Lululemon doesn't need expensive endorsement deals to sell its products. Instead, Lululemon holds free yoga classes in all of its stores and recruits fitness instructors from local gyms to become community ambassadors for the brand. Instead of paying these ambassadors, Lululemon offers them $1,000 worth of apparel and the invite to teach the free classes. That fits in with the company's healthy growth strategy focused on community involvement.

Lululemon's belief that a company can only be truly great when it has a close relationship to the communities it serves is the driving force behind the company's grassroots marketing strategy and growth plan.

It's also reassuring that the company executes its growth strategies at a gradual rate, testing each new phase of development and getting the technical features right before pushing to market. A key contributor to the company's sales strategy has been its ability to delay store openings until the demand has been created, as it demonstrated with its recent line of girls' dance apparel. 

Like mother, like daughter
Lululemon's newly launched dance and athletic apparel line for teenage girls is called ivivva athletica, and first debuted as an online storefront in Canada. Although I'm not a teenager, I couldn't be happier -- this shows investors that Lululemon is spending its cash wisely.

Ever on the cutting edge, Lululemon's new apparel line for teens will feature a "help us design" section on its website where customers can email feedback directly to ivivva designers, along with an inspiration board in the form of a blog for dancers and athletes.

Clearly, this is a company that knows its customers and brings value to its employees, shareholders, and communities worldwide.

Sustain yourself
At 43 times expected earnings for fiscal year 2012, Lululemon's stock price looks as overpriced as some view its merchandise. But can you really call it overpriced if customers are willing to pay at these price points?

One thing's for sure: Lulu's pricing power, growth potential and strong branding give it a wide competitive moat.

Whether you're a fan of Lululemon's clothing or not, it's worth keeping an eye on this stock as it continues to crush the competition. Track the company with My Watchlist, our free, customized stock tracking service. Click here to get started -- it's free!

Fool contributor Tamara Rutter owns shares of Lululemon, but does not have a financial interest in any other companies mentioned here. Follow Tamara on Twitter @TamaraRutter. The Motley Fool owns shares of Under Armour, Gap, Apple, and Lululemon. Motley Fool newsletter services have recommended buying shares of Nike, Apple, Lululemon, and Under Armour, as well as creating a diagonal call position in Nike and a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 21, 2011, at 3:31 PM, davejh23 wrote:

    "At 43 times expected earnings for fiscal year 2012, Lululemon's stock price looks as overpriced as some view its merchandise. But can you really call it overpriced if customers are willing to pay at these price points?"

    This statement makes absolutely no sense. Stocks only trade at extreme multiples if investors expect extreme has nothing to do with what customers are willing to pay for product. High pricing power among brand loyalists actually limits potential growth as a large majority of consumers are unwilling or unable to pay at higher price points. The stock worries me for multiple reasons: First, multiple analysts believe that the company has only reported the sales growth they have through fraudulent inventory gimmicks. I don't know if this is true or not, but considering the fact that many people, including myself, have never even seen a Lululemon garment, I wouldn't be suprised. Personally, I don't believe their niche is that strong, and most athletic apparel consumers are already brand loyalists...larger competitors can easily maintain or gain market share by expanding into Lulu's yoga niche.

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