Despite rising inflation, rising interest rates, war in Europe, and just an overall terrible feeling about the economy, households are still spending plenty of money on ... clothes! Quite a bit more, in fact. According to the U.S. Census Bureau, shopping on new threads is up 10% year over year through the first half of 2022, outpacing the rising cost of living.
Lululemon Athletica (LULU 0.80%) is a top beneficiary here. Granted, this isn't a new trend. Lululemon has been a high-growth business for years, one of the best in the apparel industry over the last decade. So I (finally) got off the fence and made my first purchase. Here are three reasons why.
1. Consumers are voting for quality
For the uninitiated (myself included, until recently), Lululemon evokes images of overpriced leggings and athletic-inspired clothing. That isn't an unfair visual. Lululemon has built itself as a premium brand. But that's OK.
While cheaper apparel brands are reporting pedestrian sales growth (or even contraction), Lululemon is putting up sizzling numbers. First-quarter 2022 revenue was up 32% year over year. And for full-year 2022, management's outlook is calling for total sales of at least $7.6 billion, representing an average annual growth rate of 24% over the last three years. Clearly, many shoppers are intentionally choosing quality over quantity.
Lululemon is obliterating the apparel industry's average growth rate. What's the company's secret sauce? A decade-plus trend toward athleisure (everyday clothes informed by sportswear) certainly helps. An expansion of categories, like the recent foray into shoes, also helps.
And Lululemon believes that comfort can be stylish, too. With the pandemic creating the need for ensembles to be flexible, professional, and utilitarian all at the same time, I believe Lululemon's lineup of gear that can be dressed up or dressed down will keep winning.
2. A fantastic direct-to-consumer business model
Fellow sports giant Nike (NKE -0.18%) is well known for its pivot toward a direct-to-consumer (DTC) business model. An increasing number of shoppers buy their sneakers directly from its app, website, or a Nike store, rather than from a retailer. But it isn't the only brand forging relationships with a loyal fan base.
In fact, by one metric, Lululemon has a lead in this department. First-quarter DTC sales were 45% of revenue, and digital sales have averaged 40%-per-year growth in the last three years. By comparison, Nike said its Direct business made up 39% of total revenue in its spring quarter (up 7% year over year), with digital share of the business reaching 24% of the total.
What's the benefit of Lululemon's focus on its own e-commerce biz? Higher profit margins -- a lot higher.
Data by YCharts. TTM = trailing 12 months.
With more control over its customer relationships, Lululemon can more effectively direct pricing of its products (versus a retailer partner that might overstock and then need to have a fire sale). This also plays into Lululemon's image as a premium brand, one worth paying up for in the collective minds of consumers.
3. Spendy clothes, slightly less spendy stock (than six months ago)
Lululemon has done an incredible job maintaining its growth momentum, and that has been reflected in a premium-priced stock. And after tumbling 27% this year (compared to a 19% drop for the S&P 500), the price tag is still high. Shares trade for 76 times trailing-12-month free cash flow and 36 times trailing-12-month earnings. Based on earnings for full-year 2022, that premium falls slightly to 30 times earnings.
By some measures, though, this is the cheapest value for Lululemon since the pandemic started. High-flying stocks are being punished by the market right now as inflation and interest rates wreak havoc, but thus far Lululemon has been able to mitigate these issues and is still growing fast. The stock has also held up relatively well compared to other growth stocks given its ample profit margins.
With that in mind, I plan to build up to a larger position in Lululemon over time. Think of it like starting a brand-new wardrobe, and I'm starting with a simple pair of shorts. Maybe over time, Lululemon will account for a larger part of my ensemble.
Same with the stock. My first purchase is a very small percentage of my portfolio. But I'll buy more if the company keeps proving its resilient growth story remains intact.
