Chit Chat Stocks - Lululemon (LULU) | Not So Deep Dive

Episode Date: June 21, 2022

Lululemon is a designer, distributer, and retailer of athleisure wear. The company tailors its clothing for lifestyle and athletic activities. Listen closely as Brad, Brett, and Ryan go through the history, financials, and future prospects of Lululemon. Enjoy the show! This episode is sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check-out the service here: https://seekingalpha.com/checkout?service_id=mp_1308 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to 7investing with the code "Money" and get $100 off: https://7investing.com/subscribe/aff/4/ Interested in more of Brad’s work? Subscribe to his newsletter: https://stockmarketnerd.beehiiv.com/ Contact us: [e-mail] Timestamps Company Background | (3:45) Industry | (10:24) Management & Ownership | (12:15) Valuation | (15:05) Earnings | (16:15) Balance Sheet | (20:03) Our Analysis | (22:47) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not So Deep Dive episode on Chit Chat Money. We got Brad Freeman back on the show. We're on the every four-week cadence now. So, Brad,

you recommended, or not recommended, you chose Lululemon for the research this week. why the choice? I know you said you wear some of the items, so maybe that's why. Yeah, it's half my wardrobe. So if this is going on YouTube, you could probably see that I'm in my car right now and there are wasps flying around in the house that I'm supposed to be in. So it's okay. We're doing well and moving on. But Lululemon, so it's no secret that 2022 has not been a fun time for investors. It's no secret that there's a lot of headwinds looking ahead into the rest of the year. And so my cash position has kind of grown in the last several months. And on the other side of that, really fixating on, well, what can overcome all this really not fun

stuff and what can be that actual secular compounder that we all covet and what was actually relying on Jerome Powell printing trillions of dollars and negative real interest rates and all that stuff. So for me, Lululemon is one of those companies that I'm very interested in watching kind of throughout this process so for me selfishly um you guys doing some of the research for me is is always it's always nice so uh lululemon um it's high on the watch list and excited to dig in yeah it's mutual we always that's the cheat code that way yeah that's the cheat code of the show uh as everyone's researching for outsourced outsourced research yep and as we'll get into lululemon has proven to be that secular compounder and is guiding to their goal

is to continue that with that really GDP plus, plus, plus growth over the next five years. But I'm going to let Ryan introduce him. But first, let's talk about our sponsor today. And that is Potential Multibaggers. The aim of the Potential Multibaggers service is to find stocks that can go up 10x over the next 10 years or compound at 26% per year. Now, these could be something like Shopify finding that early. And now I know Shopify has had a huge run up and run down. But even when potential multi-baggers made their recommendation on this, as put out their research on it, it was way, they're still quite in the green on this.

So it's still a multi-bagger. It is still a multi-bagger. And the key with the service is that they hold the picks for a long period of time. Of course, they have to continue performing well to hold them. And Chris, the man behind potential multi-baggers, who as we've mentioned has been on the show frequently calls this buy and verify. So if there's any scary headlines, if there's any new news out there, if there's any other research reports that cause the stock to move, he'll be giving updates to you. So if you

want a partner within your growth investing portfolio, and if you want the help with that, and you don't want to do this all on your own, the multi-bagger service is a perfect asset for you. And if you want to become a multi, you can go to Seeking Alpha and look for From growth to value, Google it, or go to at from value on Twitter. The link is also in the show notes. Ryan, do you want to introduce Lululemon? Yeah, I will. Most people I think have a pretty good idea of what they do, but I'll give a brief description anyways. Lululemon is a designer, distributor, and retailer of apparel and accessories, primarily like they call it healthy lifestyle apparel. It's some, some people, they have workout clothes, but some of

it's casual clothes and it ranges the products range from men's clothes to women's clothes. I believe women accounted for, according to the 10 K, they accounted for 67% of sales in 2021. So still primarily women, but there are plenty of men that shot there as well. One, yeah, Brad just raised his hand. One common trait among their clothes is their different products is the simplicity of design. You're not going to see any like prominent graphics or logos.

Typically, it's usually one color, very basic, and the logo's tiny, but you can spot it, I guess, like people know the typical Lululemon look, I think. And then I'm going to kind of go through the life of the, it doesn't provide any value to just go over and over what Lululemon does, but I'll go over the life of a product so you can kind of get an understanding of the logistics. So for the development stage, Lululemon employs a number of researchers, scientists, engineers, and designers that all help come up with different product designs. From there, Lululemon partners with several inspection, verification, and testing companies who test various performance characteristics, things like sweat absorption, shrinkage after the washer or dryer, stuff like that. And then once a product is ready to be developed, Lululemon has 65 different fabric suppliers that it procures from and 41 vendors that manufacture for them.

So just under 70% of their manufacturers are based in Vietnam, Cambodia, and Sri Lanka, with the majority of those being in Vietnam. Once a product is made, it's shipped to one of Lululemon's various distribution facilities, which are all located in either Australia, the US, or Canada. All of these are pretty much leased except one, which is in Ohio. So they lease most of their distribution facilities. And then once they make it to the DCs, the products are either sent to the retail stores based on inventory needs or directly to consumers' homes if it's an e-commerce purchase. And then the last thing I'll say, I know a lot of people, especially anyone that's studying retail, the focus lately has been on the supply chain.

That's been a hot topic. So I found this stack kind of helpful. From 2019 to 2021, costs incurred to transport products from Lululemon's distribution facilities to its retail locations and e-commerce guests increased by 154%. You probably don't have it in front of you. Do you know what revenue was? Didn't it compound to like 20-something percent over that same time period? Yeah. I'm not exactly sure what the revenue growth was, but the transport costs exceeded revenue growth. Part of that though, keep in mind, this is distribution centers to the end point. So that's the retail store or the customer's home. Part of that could have been the increase in e-commerce orders. I imagine fulfilling e-commerce orders is probably more expensive than bringing a large shipment to a retail location. A lot of returns to deal with too,

which is pretty expensive. About 25% of e-commerce is returned. And then as far as history goes, Lululemon was originally founded by someone I would call or characterize as an interesting character. His name is Chip Wilson. He started the store in 1998 in Vancouver, Canada. Chip Wilson received a bachelor's degree in economics from Calgary, and he always seemed to have an interest in retail. He actually started a store that sold like skater surfer snowboarder clothes in 1979 and ended up selling it 20 years later and ended up starting lululemon which at the time was a uh design studio during the day but a yoga studio at night and he did have a lot of success with this he found a lot of like found very successful

product market fit and was able to sell that within two years they had a standalone location for Lululemon gear. However, he's had some quotes that I would say make him no longer a part of Lululemon over the years. He's not anymore, right? He's not. He's no longer on the board.

He may still own some shares. I think, Brad, you looked at ownership. He might've been on there. But they had a little more context. 2007, they IPO. 2008, they hired a new CEO, but he was still involved with the company for a long time.

and he said a few things i'm gonna bring i'm gonna mention some of them so he named the company lululemon apparently because japanese people couldn't pronounce the letter l i don't know if that was like a competitive thing but he said it's funny to watch them try and say it not a good quote he also had this really weird blog post in 2009 where he attributed lululemon success to the rise of birth control um that doesn't make sense in the article he says birth control gave rise to the power woman uh and he wrapped it up by basically by saying ultimately lululemon was formed because female education levels breast cancer yoga slash athletics and the desire to dress feminine came together all at one time well that's non-coherent

i mean there's some reasons that i think there's some reasons that uh people wear lululemon that we probably don't want to discuss because it's just not spoken you know but like that those Just to be clear, he's no longer a partner, which is probably a positive. Brad? I mean, so Toby, Lucky, Shopify, he's never said anything that like misogynistic or anything like that. But Snowboard Shop, Beginnings, and says a lot of things. I don't know. There's some parallels here. But that was, I mean, the only reason I bring that stuff up is because he was, it's the history section, and he was a crucial part of the founding story, obviously the founder. and he just, uh, I don't know. It's probably for the best that he's not.

Yeah. It's like different than Nike who Phil Knight's been around forever there. Uh, but for Lululemon, it's kind of, they just, it's not like a bad thing, but they have a bunch of outside managers now, or even if they, they probably, they could be there for 10 years. So maybe they're like the new insiders. It's, it's a different sort of, um, corporate culture, I guess, than maybe the founder. Uh, but that's probably a good thing. All right.

industry and competition, super simple. I think going through this business, I actually was trying to find some things to look at because the business isn't really that complicated. The athleisure industry is surprisingly large, maybe to some people, but maybe not younger people. It was estimated to be about $411 billion in 2021 and is projected to hit $793 billion in 2028. That's a rough estimate, but it is growing quickly and there's a secular tailwind here. Yes, Ryan? I have a question. Have we ever looked at a company where the projections for the industry were that it would decline? No, no. That's what I'm saying. I look at these every time and I can never find anything. So take it what you will. Tobacco, that one's pretty well

down. But this one is pretty simple. You don't need to get the exact numbers of, oh, it's going to be $800 billion. Lululemon is going to take X percentage of it. There is a secular tailwind here over the last decades and maybe even century. People have been dressing more casually and Lululemon is taking advantage of that. Competitors out there, there's tons, but the big dogs are Nike and Adidas. And then there are just tons of smaller brands that you might group as the Instagram-based competitors, among others. I don't need to name them all, but there's dozens and dozens and dozens of them that probably do like $100 million in revenue a year or less, or maybe a billion in revenue or less. There's probably a few different tiers.

Essentially, anyone that is looking to steal wallet share among athleisure shoppers, I'm sure for any female listeners, the few that we have that are on Instagram, or you guys too, There's so many different companies trying to steal Google women's thunder. All right, Brad, do you want to hit management here? Sure. I'll do the big three. So CEO is Calvin McDonald. He's currently a Disney board member. He was the president of Sephora, also the president of Sears Canada. So, but, but that's okay. 85% glass door rating. I make that joke every single time.

We say like AOL or Sears. Yeah, that's okay. They learned what a bad company looks like. Exactly. We'll spin it positive when we want to. Right. And then really large, so 5,000 review, glass door sample size, 85% ranking. Not everyone loves that metric, but I like to look at it. CFO is Megan Frank, former VP at Ross and J.Crew, and a director at Saks Fifth Avenue. CTO, which interesting that they have a CTO, but Ryan just explained to you why they do. CIO at, I was supposed to say REI, VP at Nordstrom, and then professor or adjunct professor at Seattle University, which I found kind of cool. So in terms of ownership, it's not, so it's not founder owned as Ryan kind of laid out for you, but McDonald's owns a small portion of the float outright. So under 1%, but there are special founder shares or not, I shouldn't say founder shares.

There are special executive shares, I guess I should say that kind of boost their voting power in aggregate by 4% overall. So not a ton of voting power, but it's not super uncommon when you have companies that have had several different leadership teams and have been around for a long time. But there are a few funds with hefty stakes. didn't know about chip's background um so if you're interested in lululemon and i'll be looking into this afterwards check to see if fmr llc which owns 14.4 of the voting power um is is associated with him in any way shape or form because um i've heard of that i think that's fidelity's uh fun so

that could be yeah that's their acronym chip for i believe chip has last thing i saw was that he was selling or liquidating a lot of his lululemon steak to fund his son's retail store concept so it seemed like he's a serial entrepreneur and so it makes sense that he's kind of maybe like travis kalanick with uber like oh you got rid of me i'll just go show you up and do something like a spite cell yeah yeah exactly uh but so so that makes a lot more sense fidelity and then so pretty much every bellwether is listed um here so vanguard at seven percent hero price at six BlackRock at 6%, Prudential at 6%. So yeah, that's a pretty impressive roster in terms of votership power or voting power. Yeah. And speaking on that CTO thing,

I did listen to a good chunk of their analyst day that they recently did. And they did talk a ton about this technology stuff that they're researching in. I didn't necessarily know what to think of whether this is good or kind of just, are they trying to hype up something that's not that important, but they do go into detail. So if you're interested in that, I would listen there. It's for you. Credentials to advance, confidence to stand out in your career. At Regent University, you'll join more than 30,000 world changers making a difference in high-demand fields. Pursue your bachelor's, master's, or doctorate online or on campus in Virginia Beach. Your degree from top-ranked Regent University is waiting. So is the world

you will elevate say yes to your purpose and position yourself for a brighter future visit regent.edu slash learn more regent.edu slash learn more um all right i'll hit valuation quick since this is a retailer with no complications uh it's a lot better than what were the last two ones we did farfetch and carvana with so many complications um the market cap though it'll be easy to understand this one 34.6 billion dollars tickers lulu so just the first three letters of their company name. Price to sales, 5.2. Price to gross profit, 9.2. And price to operating income of 24. With a retailer like this, I like to use operating income because the inventory can whip around the cash flow a little bit inconsistently and they're not going to have

weird... It's more of a standard business from a gap accountings perspective. So I think operating income is probably my preferred metric for valuing this business. Share count has started to come down due to the buyback program. They're fairly mature in cash generative. So I don't think share count is a big concern, but definitely something to watch as the share price has gotten depressed in the last year or so. Hopefully they take advantage of that or we'll see how much they want to. All right, Ryan, do you want to hit earnings? Yeah. So their first quarter was what I would call really solid for a retailer because a lot of the retailers are reporting pretty bad quarters and Lululemon is not. So net revenue was $1.6 billion. That was up 32%

year over year. Just for reference, they've done about just under $7 billion in revenue the last 12 months. So if you're trying to get a grasp on the size of the business, hopefully that number provides some context. But like I said, $1.6 billion in revenue for the quarter, up 32% year year total comp sales increased 28 and that that comes from a combination of 24 comp store sales growth and 32 increase in direct to consumer net revenue so that for anyone that's unfamiliar with retailers same store sales so how much revenue there each store is generating compared to last year uh 24 growth is really really solid yeah so are they counting d2c as just one store that's no that's comparable sales from okay okay so not aggregated as well maybe it's from the same

customers that's confusing yeah maybe i'd have to look at the depth yeah we'd have to look at the definition yeah but comp store sales that number comp store sales is up 24 percent every year. Gross margin was 53.9%. That's really high for a retailer, but it was actually down slightly from last year. Part of that is the rise in cost of goods sold, the rise in freight costs and shipping, but their operating margin actually increased versus last year. So really impressive that they were able to decrease sales general and administrative as a percentage of the revenue operating margin for the quarter was 16.1 percent also during the quarter 20 of their chinese stores which china is not a small market for them it accounts for about 15 of their entire store

base 20 of those stores were closed during the first quarter completely closed and they were able to beat their revenue guidance so that to me well isn't it out the lock mountains could be a tad bit of a tailwind since people can't spend money on vacations in china what do you mean like didn't that happen in 2020 unless i'm reading to this wrong where lockdowns are a bit of a tailwind for a business like this i don't see how it would be i mean with the speakers complete store closures even so yeah they i mean they i listened to the conference going it did not sound like a tailwind they said even they were they talked about how they were able to be it was an impressive feat that they were able to beat their own guidance considering

that chinese stores were closed okay well hey i was just a little confused there but uh they were they also opened five new stores during the quarter total store count grew 11 year-over-year so comp store sales increasing 24 store count increased 11 those are kind of the two metrics you want to pay attention to for a retailer they did not part of why they were able to do better than retailers during this quarter was they said that last year because they target sort of a higher income demographic they did not see a boost last year with stimulus checks so they didn't really change spending power of their consumers so uh there wasn't that tough comp that a lot of the retailers saw also one more note during the quarter they bought back 233 million dollars

worth of stock that reduced the share count by about 0.25 percent during the quarter so if you annualize that they'd be reducing share count by about one percent all right brad you want to hit balance sheets yeah and then also wonderfully straightforward here which i can only imagine what carvana's looked like but uh so balance sheet and liquidity so 650 million in cash versus about 1.25 billion year over year um they added 300 million in inventory so it's a sort it's a use of cash um that brett was talking about which which messes with cash flow margins on a quarterly basis and why operating income is is important um very profitable it has a 400 million dollar five-year credit revolver it's got about 99 of this untapped so it's pretty much all untapped

um all of the rates uh with the rate i'm sorry with rates below two percent and then so uh for mainland china which as we just heard is a big part of their or not a big part but a considerable part of their store plan has another uh 20 million dollar revolver um which was raised to 35 million and that's also untapped um issued and outstanding share counts extremely similar so um no heavy dilution imminent in the near future and sounds like that buyback is is nicely shrinking that share count um but i mean and this is extremely common there's a lot more shares authorized so so if they want to make a large splash in mna land or anything they're they're free to do so if they want to use equity um or to hire some new talent in this in this uh world but but yeah that

that pretty much sums up balance sheet liquidity yeah and add on the inventory don't for anyone like follows them i think you know but don't ignore inventory but it can mask the cash flow we don't have them inventory growing faster than their top line um all right the other thing is they, they have a pretty, they do a good job of selling through their inventory on, I forget what it's called, Brad, you might know, but there's like the Lululemon, um, like, uh, like a rack, a rack. Yeah. It's kind of like a Nordstrom rack for Lululemon on the website, um, that they utilize.

And you can almost, because they turn, they're able to turn over products so fast and expand or like innovate and uh i guess innovate is probably the right word you can almost call stuff that's been that you weren't able to buy or you're no longer able to buy in-store like retro lululemon stuff and you can only get it from their from their inventory so it's kind of nice that way but obviously with the retailer you don't want them uh you don't want them holding on to the clothes for too long you want them to sell through it pretty quickly or else they're gonna have to mark that down yeah in general watch inventory some managers will be uh they'll try to downplay it but it sometimes can be an indicator that there's a lot of risk there probably not

happening with lululemon but it can happen with a lot of others this episode is brought to you by lakinta by windham here you are miles from home and ready to start your vacation good thing you're staying at lakinta by windham they have free high-speed wi-fi to stream all your favorite movies and in the morning get fresh waffles with their free bright side breakfast or squeeze in a workout at their fitness center either way you're ready to conquer the day tonight la quinta tomorrow you triumph book your stay at lq.com all right anecdotal evidence uh brad you're up first i want to figure out why you guys like these clothes so much because it could be you know a bullish indicator or something like that so brad it's it's a large portion of my wardrobe um i think

so i'll try to explain this the best i can it's it's like it's not flashy it's extremely comfortable there's no brand i don't like to be flashy but i kind of like to like wear nice clothing so it's kind of a way to do that without like standing out and wearing like a like a louis vuitton or whatever it is um so so and it's i mean it's it's a it's like a 50 shirt it's not like it it's not like louis vuitton it's it's sort of like um or never i'm digressing but basically very comfortable not flashy and you can wear it to go out or you can wear it to work out very flexible so yeah i don't know i like it but they're not versatile they're not exclusively that you know thing though so what separates them what do you mean there's dozens of other companies

that sell that same thing uh nice high quality first of all with the last brand i'm literally wearing some right now okay i have you ever tried it i don't know but i'm i know that the concept is similar all right i'll you asked for anecdotal evidence so i'll give you my experience i i look good in it better than i look in others clothes i'm wearing lululemon pants right now fyi the pants might be the best men's product they've ever come out with it you're allowed to wear they look like slacks and they feel like sweats secondly there is a social signaling element to it like you let's say that's the separation I mean, it's also comfortable and looks good, but the, if I'm out and someone sees the Lululemon logo, it's not like, it's not a Louis Vuitton logo, but it means it signals affluence, like, like that you can afford Lululemon.

And it's not like it's this crazy purchase price, but it means you, I guess you're like, you care about how you look and it's not a target shirt. So there's certainly a social signaling element to the business model. but i just am so confused and there's there's there's plenty of other brands like that so what like like what kim shark and yeah roan mac weldon i don't know which is those aren't recognizable it's like golfers but i thought the point was not to see the logo so you don't even know no it's it's that you it's that the logo isn't the most noticeable thing but you know you can if i see someone in a lululemon like if i see a guy in lululemon pants i know that they're lululemon pants even if even if i don't well i guess it's a mystery to me it's like the pro v1 of of golf

balls yes make a comparison that you understand i don't know that that's not i don't understand that comparison it just it just it just feels better when you're looking down at the t and you you see pro v1 looking back up at you i don't know yeah i'm trying to under well it's very important to any sort of it's probably the most important thing to the investment thesis what is the brand selling because like i get confused on that like nike yeah i get confused nike is selling like athletic greatness i don't i get a little confused on what lululemon is selling with their brand that's just the whole hold up for me i i'm like personally whatever doesn't matter but i i just get a little bit confused it's like i can i can buy that but i just good looks and wealth

but is that is that as moaty that's incredibly moaty those are like things that people strive to look for all the time i know but that no i don't know if it's as big of a moat as nike's because nike said that 10 years ago no no it's different though it's because it's different like, obviously, Lululemon has executed phenomenally, but is the defensibility there? Because I just worry about- I would say yes. My answer would be yes. I think this is extremely subjective. And it's kind of what you have to kind of decide on your own if you think this is a viable investment. I think this is the question. How strong is the brand equity? Because when you're investing in a consumer discretionary brand, you are relying on

it's staying relevant for a long time and that has to happen. So I think yes. Other people will think no. And I think that's kind of our readers or viewership basis job. I think the price of power also explains it. Yeah. If you're able to constantly raise prices, which they have, and I still go back and purchase, I mean, it's a testament to the brand. Yeah. I don't know if my answer is no, but that's what my concerns are in my head about the durability compared to a Nike or Adidas. All right. Future growth opportunities. I got no anecdotal evidence. I don't know. But future growth opportunities, Brad. Yeah, so international expansion. It seems pretty early innings there. I've heard, I brought up Lululemon on Twitter

and got all of these messages from people in Spain and Italy about stores opening to extremely long lines. So some more anecdotal evidence, but future growth opportunities just in that. In Western Europe, in some parts of APAC, this niche of affluent consumers has a very large cohort to go after. And I think it's very early for them there, so.

Yeah, Europe will be a tougher hill to climb, but it seems like the trend, the overall trend has, you know, formal wear is more common there, but the opportunity is still quite, quite large. Athleisure's really got big in the United States and I think it's kind of blossoming from there. So we'll see how, how effectively you can do that for them. Yeah. We'll see. Yeah.

The market share can get the same as the United States. That reminds me is part of the importance here. the stores is the store because it feels like they have everyone calls a store an apple strategy store but do they have it from what i've seen walking around their locations the way they're presented do they and the way they treat their employees as kind of these like uh high quality maybe it's more for the women the free tailoring is really nice sorry the free tailoring is really a really nice perk they they'll they'll like tailor your clothes for you for free they're not very good. That could be an advantage. I mean, it's not an advantage over Nike who I bring them

up. They're not really that big of a competitor with Nike, but the, uh, it's definitely an advantage. The store is probably over a smaller D to C that can't have that. Yeah. It gives a good, like for first time, I think e-commerce is more catered to repeat purchasers, but for the first time customer having the store, um, to go in, see different products, be able to try them on. And then, you know, what you like, you know, what your size is for whatever pants you don't have to go in next time, but I definitely think it helps for the first original customer. Yeah. All right, Ryan, what's your future growth opportunity. It seems like you have an anti future growth opportunity. Yeah. I mean, I think you two took the two that I probably would have gone with. Um,

i was thinking about saying smoothie bars inside the stores no and they did try that in chicago just because it kind of plays into the whole healthy lifestyle athleisure thing but that's that's next that that's next that that's why that's why it's not on my uh future growth opportunities my future growth opportunity is that they don't make any more acquisitions i think they've done a terrible job and so uh you don't like mirror what uh what have they done besides mirror that i'm unaware of that's all that matters well i mean yeah that's been bad but i don't know if they've made any other ones but i don't want to see them make another mirror acquisition yeah they don't even talk about that anymore they talked about the analyst day they

brought in a new head of that and they have a mirror plus subscription so shout out there we go that's going to, yeah, game changer. They're going to write off that whole thing. No, I think that, yeah, I think so too. The game plan is pretty simple here. Add new stores, continue to expand your product offering into other, they've done a good job with it so far, but other lines, other categories.

And then I also think by expanding your product offering, it makes, it gives you a little more, it gives me as an investor a sense, a better sense of surety that they're not just like a one product company like they maybe were whatever 15 years ago with yoga pants right now there's more yeah you've got men that like the lululemon brand for a lot of reasons women like it for a lot of reasons as well um also continue to increase prices i think you've got a customer base that can eat those price increases what do you think is what's the ceiling they're at what a hundred bucks for a pant now what's the ceiling

at least 108 130 i is what they 130 is what their pants cost depending on what i was doing i was doing the um i looked up the the elastics the yoga pants it was 100 but yeah the you're talking the other types i think i mean it always changes like with each year but if there's a difference between are these like here's the question are these jordan shoes that can have basically infinite pricing power i don't think so but are they whatever the quality nike shoes that they can pump up 10 bucks a year yeah 150 to 200 bucks i would gradually gradually increase prices that is, I don't know, probably a mid single digit to high single digit clip. The, my, the thing is they last long enough in my experience that I have no problem paying

a high cost because I don't have to go in and buy them again in a year. Yeah. But that's a lot of, I mean, that's Nike. I've had Nike shoes for five years. Yeah. You've had Nike shoes for five years. Yeah. That quality. That is impressive. You get a good pair i don't i can't say i've ever had like a frequent shoe that i use five years but the uh i don't know that's that's sort of the basics of the the way they're going to grow and then buy back shares opportunistically when the time's right i think they did it well this quarter if it stays where it's at right now i got a feeling they'll do more this year yeah for sure all right my opportunity is shoes uh they just entered this um they launched what

was it March? I think was the official launch some around it pretty recently. They said it went really, really well. It would be tough to dethrone the top dogs, Nike and Adidas and running shoes, which is basically what they entered in and flip-flops as well, I believe are slides, which are two adjacent categories, but this is a gigantic category. I, I don't have the numbers. I probably should have gotten them, but their shoes are huge as everyone is well aware of.

And they could be the next big thing for Lululemon to keep revenue growing at that 15% to 20% clip this decade, because yeah, I don't really think there's anything else. There's no complications here. Shoes are huge. They execute well. That's a whole nother thing. Instead of someone buying the pants for a hundred something bucks and that's it, you can double that and double your, you know, the shoes and the pants. without more customer acquisition costs so yeah yeah if they talk about their technology with them and i'm like yeah yeah yeah i got it every company talks about that but either way they seem

the demands seem to be there yeah i'm looking at their shoes right now it looks like they're primarily for women it's limited yeah there's only women limited now yeah that seems like the next easy market for them but i feel like shoes are just hard to get right yeah i worry about them competing with again the established players all right highlights low lights brad you want to go first yeah um so i i think this is a generation or generational brand um i think uh it's nike and adidas and then lulu clearly it used to be nike adidas and under armor and i think they've obviously clearly replaced them as that number three brand and carved out a really appealing niche with more affluent customers, especially as inflation rages on and discretionary purchases

become a little bit less palatable. I mean, for the more affluent consumer, they'll still shop at Lululemon. They're less impacted. So that, but then also just thinking on the macro theme, like Brett was saying, there are so many knockoffs of Lululemon and that fringe customer that can sort of a four little lemon, but maybe sort of not. They're probably going to be more motivated to go seek those discounts as the economy continues to weaken. Gymshark is a brand we threw out there, but there are a lot more. So yeah, that would be the low light for me is how, again, how different, and I don't have the answer to this. It's very subjective. How strong is their brand versus all the other cheaper options where they'll continue to fetch

these sales and this demand across economic cycles. I guess if pricing, not pricing, consumer pricing power, not power, what am I saying? The firepower in their wallets, if there's a recession that hits, whatever, all that sort of stuff, I think the listeners understand it'll be a good test for Lululemon. Yeah. All right, Ryan. Highlights for me, four things. Really remarkable brand i think i can kind of sense it when i wear it and you can just you can kind of just tell anecdotally uh they have a resilient consumer demographic uh it's much better in a recession i imagine to be with the high income demographic than penny pinchers uh potentially like i would rather be with the lululemon than a target in this instance um they also have a history of

really successful product expansion which i like to see and i think they have pricing power low lights for me uh the the mirror acquisition felt like a fomo acquisition it felt like that when it happened yeah well are we talking about what we forgot to talk about the peloton apparel line which as people said was going to be as big as lululemon no sorry that's uh oh i thought i thought you meant lululemon launched a peloton apparel line no no peloton remember peloton apparel guys when foley's wife was going to take that over before they all collapsed sorry that's a side note but anyway the mirror acquisition was a in my opinion an absolute waste of 500 million dollars that is i that's 500 million dollars that could have been returned to

shareholders in some way or used to expand store count it is a big knock on management yeah that is sort of a big i'd call it a yellow flag for management i don't like when management teams do stupid M&A. Um, I also struggle with retail, like as optimistic as I am about the Lululemon brand. How optimistic would you have been an Under Armour in 2012? Like I would have been. Or LA Gear in 1980. Yeah. It's, it's just, yeah, it goes through trends. I think they've done a good job for me, making me feel a little more safe as an investor because they've been able to diversify across uh genders and categories but that still doesn't completely like save them from brand tarnishment down the road yeah and they can't like lock up

the lifetime i don't know yeah i have a harder time uh getting to like the lifetime value and moat like describing that with a retail company well because they can't lock up like lebron james it's not one economical for them and two it doesn't make sense are there is there any way they can separate themselves even further do like dust maybe go no they said oh this johnson isn't he other analyst that yeah there's there's some there's another analyst they said they had they said they got the 20th ranked uh women's tennis player in the world and i was like she will crush me in tennis but i was like guys come on all right yes hey good for her she probably got a lot of money but i'll uh i'll hit my highlights i mean high margin category uh a lot of the

i don't know retail concepts or whatever they don't have the margin that there's room here to say absorb some cost pressures stuff like that um they elevated themselves the last say five to seven years out of kind of like the middle of the pack DTC brands, which is really, really tough to do. And it seems like the hard part is probably over. And then the omni-channel strategy, I do like how that gives them an advantage, like we were talking about before, catering to the core customer. And then I do like the potential expansion into shoes. Lowlights, high employee count of 29,000 gives them a major risk to wage inflation. And I think if they talk about how the Lululemon employee is so important to them that they might have some pricing power in their wages

that we'll see. We'll see. I mean, they have that great glass door rating, but I think there's a risk there. At least they won't be moving to be Peloton instructors anytime soon. Right. The products made in Asia also, there's the transportation and energy costs there. ryan mentioned that before they're growing faster than um revenue and while that's not something that's like a huge negative it's just makes the business or not the business the industry just you know just makes it less attractive yeah and then like i mentioned before i don't truly understand the brand they're selling i feel like they need it maybe this is how the ceos are talking not ceos the executives are talking at the analyst day but it was a bit like

mismatch um i'm sure their commercials are better than how they talk but yeah i don't know if i ever see yeah lemon commercials or whatever they only advertise it somewhat but yeah yeah i'm sure they do uh let's go bull case brad what do you have yeah so i'm gonna tie my bull and bear case together because it's pretty much yin and yang this happens or it doesn't happen um and it is the main theme of this is is brand strength and brand equity and brand durability and how sustainable do we think that can be? And that really builds or doesn't build, um, the investment case is being really appealing. Uh, so it's, it's bull case. This is a, this is a luxury Nike, a luxury Adidas, uh, with, with the, with the kind of a more affluent niche. And then bear case,

I brought up the name LA gear, which was in, I think half of my economic textbooks, um, in an undergraduate on, on just a case study of, of a juggernaut in fashion and in, in, in, in luxury fashion, not luxury, but in everyday fashion in the 1980s that just really disappeared because they stopped releasing relevant SKUs. And that's always a risk for companies like this. Yeah, I'll go ahead. Just to put some numbers on it, if they generate 10% comp sales, so their stores generate 10% growth each year and they grow store count by 5% each year, and their operating margin stays steady for the next five. So all that is five-year projections. That gets them to just under $14 billion in revenue and about $3 billion in

operating income. Assuming 20 times operating income in year five, that would be about a $60 billion market gap. Today, I think it's $34 billion. So you're almost getting a double over five years. All those numbers seem very realistic to me. yeah yeah i mean we i'm sorry to chime in we do we do companies where i think we're used to seeing 20 times sales and this is at 27 times earning so it's kind of like ah that's not that but i digress sorry go ahead and that's even like i'm putting 20 times operating income on my bull case but that's cheaper than it's traded at historically so you could see a world where the valuation is higher than that yeah i don't i don't like knowing that but even though nike has historically traded

at a premium at least recent history i don't believe these type of companies deserve a premium multiple but uh that could be some upside you have here uh because sometimes they do and i just i'm sorry to interrupt again i i think that nike deserves it but lululemon doesn't deserve it but if lululemon can kind of catapult themselves into that nike category then they will deserve it if that's where it makes sense. I think that does make sense. Yeah, I have a similar stuff. I mean, if they grow close to their target,

which is to double revenue by 2026 based off of 2021, I believe. It might be a different year, but pretty close. And they maintain close to current profit margins. Stock will do fine. There's nothing really else about it. Even if you get a little bit multiple compression. All right, bear case,

Brad, you said LA Gear, which, you know, losing the brand strength, Ryan. It's not likely, but, but that's the, yeah. Yeah. My, my I guess my bear case is that cost increases persist and they have a hard time totally passing that through to the consumer. So if, if operating margins go from last 12 months, they've been at about 20%. If they went drop down to between 10 and 15%,

I could see this be being an underperforming underperforming relative to the market investment. Also, if the China COVID policy gets worse and they have a hard time over there, since that's sort of an emerging market for them, and it's now a pretty sizable chunk of their store base. Yeah, it makes sense. Mine's similar. Margin compression, I feel like is a big risk here just because it is fairly healthy. And then if you combine that with top line growth slowing, there's some arguments to be made that there was an acceleration in athleisure over the last three years. I think that's a good argument. Yeah. So I wonder whether they were growing quicker than they will be. That is it, is it concerning me? And if that slows down combined with margin

compression, that's not a good recipe for success. All right. More or less interested, Brad? More for me, for sure. All right, Ryan. More, I hate, I hate investing in retail, but more It's trading at one of its cheapest valuations And it's a business and brand I really like Yeah, I want to say more But it feels like this is Three to five beggar potential Over the next, I don't know, decade, right?

Like there's so much potential here But I can never get a good read on retail I think I need to make an artificial rule To just avoid the sector But remember, the Brett Inverse Retail ETF No, no, we said that about Peloton I was right I was correct

You said we're all in your inverse ETF for retail. Yeah. I, we said that about Peloton. The Brett retail short book. Yeah, no, the,

it, there's an easy path to this being a great investment. Here's the big concern. I, for me, I just don't like brand notes. I think that's the, that's the concern.

I get nervous about brand notes. And again, listening to their analyst day, Their execution has been fantastic And hats off to them But they have to work so hard I don't want companies to have to work hard That's fair

Alright, let's So is that less interesting? Yeah, less interested But obviously Fantastic business Yeah I'm peeking over I'm peeking through

Peeking over the facts I will be watching what they're doing Brad, your choice For four weeks from now What do you got for us? I feel like in 20 years Brad's going to have a child That only shops at Lululemon

And he's going to be like, damn, now I have to own the stock. Once it starts impacting your bank account, you'll see. But we are shifting from one of the brands that I consume the most to the other brand that I consume the most. So from Lululemon to Chipotle for our next episode. So I think I eat there more than any other restaurant in the world. So a fan of them as well and excited to dig in. All right. Two favorite compounders that the stocks are down.

And for anyone that follows Brett on Twitter, they know that Brett had a bad burrito and he is contemplating Chipotle's quality. So I go forward to their case. The food quality is going down. That is a bear case. All right. That's going to do it for this episode. Remember to give us a review on either Spotify or iTunes if you enjoyed the show.

Brad, stock market nerd. Stockmarketnerd.com. All right. That's going to do it. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are, however, general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast.

Thank you all for listening. We'll see you next time.