Since its high of $82.50 in June, some may be considering Lululemon Athletica (LULU 2.09%) to be a good value at its current price of $45. For reference, the P/E ratio is currently 23.5, compared to an industry average of 28.8. Although its financial position is great with $600 million in cash and no debt, Lululemon is showing signs of heading in the wrong direction.
In the 2013 Q3 report, the company outlines that "our growth strategy relies on positive comparable store sales and expansion in North America, particularly in the United States." Only time will tell where new CEO Laurent Potdevin will steer the ship, but if he follows their proposed strategy, I am afraid that the yoga apparel company's customers won't be the only ones sweating. Here are the problems that I see with their growth strategy, keeping me far away from this company at its current valuation.
The U.S. market is one size too small
Sales growth is slowing at Lululemon: it has gone from 57% over four years to 45% over three years to 37% for the past year. Comparable store sales for the 3rd quarter were only 2% higher than a year ago. It is normal for a company's growth to slow as it increases in size; however, I think this shows signs of trouble for Lululemon. For starters, 95% of Lululemon's revenue is generated from the United States and Canada (65% and 30% respectively). Because the company's proclaimed future growth lies with expansion in the U.S., it could be said that any potential for the future of this company parallels the U.S. yoga market.
According the the Yoga Journal, the 2012 yoga market in the United States is $10.3 billion annually which includes money spent on yoga classes, equipment, clothing, vacations, and media. This market has grown at 16% per year since the last study in 2008. Lululemon has sales of $1.56 billion in 2013, so that means that revenue from the U.S. alone is $1 billion (65%). This means that Lululemon is currently holding roughly 10% of the entire yoga market.
If you assume that the 20.4 million Americans who practice yoga go to one $10 yoga class per month (on average, it is much more realistic to think some go to ten and others don't go at all) that accounts for $2.4 billion annually of the above market. I am not sure what qualifies as a "yoga vacation" or "yoga media" and how much is spent annually on it, but as you can see, Lululemon already owns a huge percentage of what is left for the apparel market. Because of this, I don't see too much more space for expansion in the U.S.
Some final thoughts about the U.S. market. Yes, Lululemon is worn by people other than those who practice yoga. Yes, the yoga market is growing, along with the markets for athletic clothing. And yes, women (especially college students) are making yoga pants more of an everyday fashion staple, meaning they are buying more. But whether all these people need Lululemon yoga pants over the twenty other brands that you can find from a trip to the mall is uncertain, and I don't like uncertainty. With all that in mind, I think Lululemon is running out of space in the U.S. marketplace and will have to expand to other countries to justify its current valuation.
Internationally, Lululemon is a lightweight
The problem with international expansion is that Lululemon is not positioned well in that market, nor does it seem to want to be. Currently, the company owns twenty-five stores in Australia and three in New Zealand. That's it. Compare that to some of the competition in the international athletic apparel space, Nike (NKE +1.57%) and The Gap (GPS +3.20%).
Nike, which is a $62.8 billion company, operates 450 non-U.S. retail stores. This does not even include the presumably countless other retail stores that carry Nike apparel but are not Nike-specific. With 55% of its revenue coming internationally, Nike has established a brand in Europe, Asia, and Latin America-all areas that Lululemon hasn't touched. Until I see success in some of these markets, I will assume that Lululemon cannot sell its apparel in new countries based on the product alone.
Even if Lululemon tries to sell its clothing internationally based on the experience of being in its stores, the smiling community, and other aspects of its brand, Gap's Athleta brand is following close behind. Athleta has tried to duplicate some aspects of the Lululemon experience: still focused exclusively on yoga, still offers free classes and community in the store-with the bonus of larger selection and lower prices. Although significantly less than Nike, Gap also has an international presence that gives it an edge over Lululemon. In the most recent quarter, Gap and associated brands did $3.98 billion in sales-7% from Canada, 6% from Europe, and 8% from Asia. If Lululemon is to survive overseas based on the aspects of its brand, it has a lot of catching up to do in terms of brand awareness.
The final word
It would seem to me that Lululemon is in a tough position, presumably the Crane Pose. It has much bigger, more established, and perhaps better competition in the international space, keeping the barrier to entry high. In the United States, where Lululemon is a market leader, I believe the market may be running out of room for growth. Based on this, I think Lululemon's price as a growth stock is still too high. I would like to see the P/E ratio fall to somewhere closer to 16, which is the growth rate of the yoga market in the United States. I like Lululemon as a company and think it could settle into a U.S. niche, but I would not buy it at this price.
