We are upgrading Lululemon Athletica (LULU) — which designs and sells athletic apparel, and markets its yoga-inspired clothing — to a buy rating with a target price of $150, asserts John Staszak, analyst with the leading independent Wall Street research firm, Argus Research.
On July 24, Lululemon announced that it had appointed Calvin McDonald as CEO, effective August 20. For the previous five years, McDonald had been president and CEO of Americas for Sephora. We think McDonald’s background will be beneficial to Lululemon as it seeks to tap into international markets and grow its e-commerce segment.
In our view, the company has the potential to open additional stores in the U.S. and internationally. The challenge, of course, isn’t to simply open stores. The challenge is to open highly productive stores, and the company has an innovative process that is helping it to achieve sales of over $1,100 per square foot in the first year a store is open, compared with an old target of about $750 per square foot.
Lululemon typically looks for street and mall locations that are close to yoga studios and fitness centers. Initially, the company will enter a new market with a showroom that is roughly 700-1,000 square feet in a less expensive location. These showrooms operate on a limited schedule to enable the manager to build relationships in the community by visiting the best yoga instructors, running coaches and trainers in the area.
Lululemon tries to find the professionals who share the company’s values as part of its word-of-mouth marketing. The manager will hold trunk shows, in addition to running the showroom, to build awareness and reach customers. The company intends to expand its showroom presence in Europe and Asia. We estimate that showrooms have recently generated sales per store of approximately $500,000 per year.
Once a store is open, the staff members — called educators — try to maintain a connection with customers by hosting weekly yoga classes. The stores have community bulletin boards designed to position the store as a hub of information for core customers. Stores also have a community coordinator whose job is to build a marketing plan with connections to important athletic and charity events in the area.
The company’s product development is also very connected with influential professionals, or ambassadors, who like the brand. The designers regularly meet with athletes and practitioners in local markets and they also work in stores to get direct feedback from guests.
We like the vertical integration in the current market because the company has the structure and expertise to develop unique proprietary merchandise. A differentiated product offering is important amid the prevalence of internet price comparisons. The company is constantly testing new products and incorporating the most promising innovations into its core products.
Lulu is planning to grow sales by providing merchandise for more sports and activities. Running has grown to about 20% of the business and the men’s business has significant upside. LULU is pushing for the Men’s business to be 25% of sales within the next few years.
The company also seems intent on developing ways to make its products more supportive and comfortable. It is working to develop lighter fabrics and anti-chafe technology, as well as fabrics that don’t retain odors as some polyester fabrics do.
With substantial opportunities to expand outside of North America, particularly in China, a strong brand and a growing number of e-commerce sales, we think Lululemon’s growth prospects are among the best in the apparel sector.
