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Lululemon: ‘Catalysts that drove growth have run out,’ analyst explains

Bernstein Analyst Aneesha Sherman joins Yahoo Finance Live to talk about why she thinks it's time for a "reality check" on Lululemon stock.

Video transcript


- Lululemon shares have skyrocketed over the last five years, rising nearly 300%. But Wall Street analyst says that astronomical growth might not be sustainable year after year anymore, writing in a note to clients this week quote, "It's time for a reality check on shares of the popular athleisure brand." Joining us now is the analyst behind that call, Bernstein's Aneesha Sherman. Nice to see you.

So why? What has changed? Is it the company? Is it the economy, or is it both?

ANEESHA SHERMAN: It's a little bit of both. So Lulu has been, as you said, a phenomenal growth story. It has grown at a 25% compound annual rate for the last five years, which is really significant growth. But two things have changed. One is that the catalysts that drove that growth have run out. There was a catalyst of e-commerce investment, e-commerce growth. There was a catalyst of COVID where we wore athleisure at home for a year and a half.

And then this year has been the year of revenge spending and getting out for social occasions and wearing more lifestyle and shoes and belt bags. And those have been highly successful products. We don't see a catalyst like that for 2023. And on an $8 billion business, it's not going to maintain that clip. So we have it slowing down materially to a kind of slightly below mid-teens growth for this year.

And the problem with that is that the growth, the top-line growth drives all of the earnings growth. So its deceleration there is going to drive a deceleration in the earnings profile as well, which we think we'll have, from about 33% last year to more like mid-teens this year.

- And Aneesha, challenge that Lululemon has been dealing with now for a couple of quarters is inventory pile-up. It was what, 85% in the third quarter? Are you seeing any improvement, or I guess, how long until we see an improvement there? And what does that signal, just in terms of promotional activity that's going to be necessary down the road?

ANEESHA SHERMAN: Yes and no. So we will absolutely see sequential improvement. Management has targeted getting to a 60% year-over-year increase down from that 85% by the next quarter. They are doing a lot of clearance right now. If you go into their stores, if you go on their website, you'll see a lot of product in their we made too much selection. So they are trying to clear that inventory.

However, this is a brand that does not like to promote too deep. They don't like to do too many markdowns. They try to keep their full-price profile, so they're not going to be doing aggressive clearance the way we've seen from some of the other brands. And so, yeah, they're going to carry a higher inventory balance for several more quarters before it gradually normalizes as they buy less product and sell through what they already have. So it's going to be a slow wind-down over the next year or more.

- Their latest push was both in women's athletic shoes, and of course, the fitness equipment, the Mirror. How successful were those or do you expect them to be down the road?

ANEESHA SHERMAN: I don't think either one has been particularly successful. You know, shoes is a very competitive category. It's got big giants like Nike that dominate market share, that dominate top-of-mind awareness and brand loyalty.

And it's also a difficult product to get into. You need R&D. You need credibility, run performance. So it's a hard one for new entrants, especially Lululemon because it has credibility in apparel, not in footwear. So we've seen a lot of the footwear on clearance at the end-of-year sale. That clearly seems like sales have not been at the level that management expected based on what we've seen on their promotions.

And then the mirror product was bought at the peak of COVID when we thought connected fitness would be a trend that lasted forever. When we look at Mirror compared to the market leader Peloton, I mean, Peloton is over 20 times the size. And it's still not profitable. So I don't think Mirror is ever going to be profitable on its own.

The way Lulu is thinking about it now is as a customer acquisition. So you purchase the membership. You try out Mirror, and soon you become a long-term customer of Lululemon's apparel. But I would argue there are cheaper and more higher-return ways of attracting new customer acquisition than purchasing this brand. So I don't think either one is going to be particularly successful or moneymaking.

- Aneesha, you mentioned Peloton. Let's talk about it. You also covered that stock. They have earnings out next week. Shares clearly have been under a tremendous amount of pressure over the last two years. In the last year alone, stock off nearly 50%. You wrote, in a recent note, that you are more bullish than ever on Peloton. Why?

ANEESHA SHERMAN: Yeah, so Peloton, speaking of reality check, Peloton had a big reality check coming out of COVID, where the level of demand that it was seeing significantly dropped. The price tolerance for paying $2,500 for a bike started to run out, and their sales started to dwindle on really tough comps.

And so they've taken their medicine. They've done what they needed to do to fix the business. OpEx has been cut by half, quarter-over-quarter. They've cut down marketing. They've shut down showrooms. They've outsourced some of their manufacturing to try to make their cost base less fixed and more variable, so it's more responsive to demand.

They've made some headcount reductions. They're selling a facility that they thought they would need, and turns out they don't need that much manufacturing. So they've made a lot of changes.

We haven't seen the impact of those changes in profitability yet because there have been a lot of one-off costs, but once you strip out those one-off costs, you see that margins are improving. They're going to be free cash-flow positive by the end of this fiscal year is what they've targeted, and I think they have a reasonable chance of getting there.

And most importantly, the core business, the subscription business still shows healthy metrics. I mean churn is still below 1 and 1/2%. That is lower than the cable companies, the phone companies, subscription businesses like that. Engagement, when you look at user engagement, use of the app, that remains at all-time highs.

So they do have a healthy core. They just needed to fix their cost base and reset, and I think they have done that.

- All right. Nice to hear. Got in 30 minutes on the Bike this morning. Aneesha Sherman, nice to see you. Have a good weekend.