7/13/2010
By Brian Sozzi, Research Analyst

More Articles by Brian Sozzi

Approximately one month into my newly inked membership at NY Sports Club, I must say the experience has been chock full of pleasure.  Two a day gym sessions have become the norm rather than the exception, and so has the exposure to young men who resemble the cast of MTV's "Jersey Shore."  Most of these gym newbies, as I have coined them, have zero idea about muscle training, all they know is that if they suck down enough chemically enhanced creative shakes some form of muscle will magically appear.  I digress, however.

While hitting it hard at the gym so to speak, I would be lying if I said I did not notice the multitude of posters to sign up for classes such as zumba, hot yoga, and even mixed martial arts.  I watched curiously at a hot yoga class the other day and aside from the steam on the doors, my analytical brain observed one key tidbit...many of the women were wearing trendy, technically oriented yoga gear.  Unlike men who roll up in the gym in a lame looking tank top, an old pair of sneakers, and the ever cool shaker bottle I sense that women put much more thought behind what they were to the gym (everyone has different reasons, I am sure).  This all got my wheels turning, how is the best way to tap into the market for gym inspired women's apparel, especially those pieces worn to attend hour plus classes?  The answer was as obvious to me as eating an apple after an intense workout, Lululemon (LULU).

Lululemon at a Glance

I have made it a point to follow Lululemon even though it's not contained in my coverage universe.  The financial numbers the company produce quarterly are eye-popping, and very evident of a business model that is capitalizing on a near $27 billion yoga inspired apparel market according to U.S. News and World Report.  According to that publication, there are roughly 18 million people in the U.S. that practice yoga, and increasingly the exercise is capturing the attention of stressed out men.  Given the small size of the market presently, it's safe to assume that growth, driven by new entrants and new gym classes, is set to expand meaningfully in coming years.  With ever growing stresses on households, how can a relaxation anchored exercise such as yoga not gain a greater fan base?  For its part, Lululemon displays all of the characteristics of a company, in spite of being in business for 13 years, which is still in its early development phase.

Competitive Strengths
* Premium active brand (prices for a men's t-shirt, for example, touch $72.00)
* Distinctive retail experience (open floor plan and not a ton of inventory on the racks)
* Innovative design process (marries technology with a touch of style)
* Community-based marketing approach (links up with gyms to drive brand awareness)

Areas of Financial Opportunity
* Ecommerce (transactional website recently launched, allowing for selling of merchandise outside of the core U.S. and Canadian marketplaces; online represents only 7% of annual revenues)
* Expansion into new product categories (I would think shoes and personal care products will eventually be in the mix)
* Expansion of supply chain to manufacturers outside of China (75% of goods are currently sourced directly from China)
* New retail square footage (store count is 150 at the moment)

Recent Financial Highlights (first calendar quarter)
* Inventory up a mere 13% on a 69% revenue increase
* Gross margin up a whopping 1090 bps on improved product costs and strong sell through
* Direct to consumer (includes ecommerce sales) sales up 952%

How the Business Has Trended

Where the Business Could Go

The Wrap

Clearly, if I told you Lululemon shares were cheaply valued it would be fair to say I had shot up too many steroids (which I do not do).  The stock is valued at a P/E multiple of 27.1x estimated 2011 earnings and 3.6x sales, off the historical averages, but at stark premiums to most specialty apparel retailers.  That said, the stock was reined in about 13% during the recent market correction and from what I can decipher, the outlook for growth continues to be very promising.  I ultimately expect the company to be acquired but at this time, given the industry-related catalysts and the stellar execution by management, I reason Lululemon is one stock to own from consumer discretionary land.

Brian Sozzi
Wall Street Strategies