At the beginning of 2012, I set out to form The World's Greatest Growth Portfolio. Though I can't promise it will always live up to its moniker, the portfolio has returned 23% in just 11 months, beating the S&P 500 by about 9 percentage points.
A few weeks ago, I outlined exactly how I would go about building my portfolio for next year: Invest first and foremost in companies that demonstrate exceptional levels of innovation, with special emphasis given to those that I believe will be around decades from now.
Today, I'm going to look at lululemon athletica (NASDAQ:LULU), one of my portfolio's best performers from 2012, having gained 60% so far this year. Read to see what I plan to do with the company this year, and later I'll offer access to a special premium report on the yoga retailer.
Clearly on to something here...
I first bought into lululemon in December 2010. Since then, the company's stock has risen about 180%. A lot of that has to do with the growing popularity of the lulu brand, its quirky stores that offer free yoga sessions, and its ultra-comfortable gear. Put those three things together and people don't mind paying top dollar for some athletic clothing. In a lot of ways, I think of lululemon as the higher-end, more women-targeted version of Under Armour (NYSE:UAA).
Last week, the company reported earnings that generally pleased investors. For the first nine months of 2012, revenue was up 41%, earnings were up 46%, and free cash flow went from a previously negative figure to $41.3 million.
And while those figures are encouraging, there were two more tidbits that should have gotten investors really excited. The first was that comparable store sales were up 18% -- which shows that a lot of the growth is coming organically. The second was that the e-commerce segment increased revenue 112%, and now accounts for 13.4% of all revenues, up from 8.9% last year .
In plain English, this means that more and more people are finding out about -- and liking -- what lululemon has to offer. People are spending more money at already-established stores, and those who can't make it to the stores are going online to get their lulu fix.
With North America accounting for 177 of the company's scant 201 locations worldwide, there's still lots of room for growth -- both in North America, and in foreign markets that show a taste for lulu's products, such as the Asia-Pacific region.
But there's a reason to be cautious
Hidden in all of this good news, however, are a couple of troubling pieces of news. First of all, while revenue was up 41% so far this year, the cost of that revenue rose almost 48%. That's important, because it means that the cost of the supplies lululemon uses to make its ultra-comfortable clothes is rising pretty fast. Lululemon isn't the only retailer dealing with such trends, as Deckers (NYSE:DECK) has been absolutely killed by rising input costs as well.
This trend could either drive up the prices of the goods or lead lululemon to change the material it uses. I highly doubt the company would pursue the latter, and whether or not raising prices is a practical solution remains to be seen.
With the costs rising faster than revenue, I was curious as to how lululemon was able to grow earnings more than revenue. Reviewing the company's income statement, it was simply because income taxes only nudged up 4.8% -- a minuscule increase compared to its taxable income. Though that's certainly nice for the company and shareholders, it's never a good idea to rely on such things to sustainably prop up earnings.
Taking these things into consideration, and the fact that such companies as Nike (NYSE:NKE) are making competitive moves to enter the yoga space, I could see myself moving lululemon from a Tier One holding to a lower-allocation Tier Two holding.