Lululemon Athletica (LULU 0.22%) has risen up the ranks and successfully carved out a niche in the competitive apparel sector. Its shares have been a big winner, climbing 672% in the past decade (as of Dec. 12), a gain that beats the broad S&P 500.
The consumer discretionary stock got a boost recently after management reported better-than-expected financial results for the third quarter. But shares still trade 23% below their all-time high.
You might be considering adding a position in Lululemon. However, take the time to know these three things first.
1. It's a premium brand
By emphasizing high-quality fabrics and innovative designs, and positioning itself as the leader in the athleisure category, Lululemon has become a premium brand in the industry. This is a key part of its strategy to differentiate itself from mass-market rivals. The company's products are more expensive than those offered by Nike, for instance, helping it target a more affluent demographic.
The result is impressive profitability. In the past five years, Lululemon's gross margin has averaged a superb 56.9%. That's well ahead of industry heavyweight Nike, but it's also better than a consumer favorite like Apple.
2. U.S. troubles
Lululemon's international business is thriving. Last fiscal quarter, sales in foreign markets jumped 33% year over year. Unsurprisingly, China is a huge growth engine, with revenue soaring 39%.
Because the company only has 138 stores in the world's second largest economy, compared to 373 in the U.S., there is clearly potential to rapidly expand in China in the years ahead.
But the bulk of the company's business comes from the U.S., which belongs in the Americas segment. Sales here, a figure that also includes results from Canada and Mexico, were up just 2% in the third quarter. Same-store sales, on the other hand, dipped 2%.
"The U.S. did come in overall in line with our expectations for Q3," Chief Financial Officer Meghan Frank said on the earnings call. To boost performance in the U.S., Lululemon is focused on "increasing the penetration of seasonal newness within our assortments," according to CEO Calvin McDonald, as well as "chasing into updated colors, prints, and patterns to provide guests with more options."
The extremely competitive nature of the industry doesn't make things easy; management must constantly try to figure out not only what styles, designs, and colors consumers will want ahead of time, but also the right amount of inventory that helps maintain the brand's image. This is always a challenge.
But over time, the business has delivered. Its expected fiscal 2024 sales of about $10.5 billion would be 163% higher than five years prior. Zooming out, growth is still a very important piece of the puzzle.
3. Its capital allocation
Lululemon is very profitable enterprise, especially on a cash basis. Through the three quarters of fiscal 2024, the company generated $417 million in free cash flow. This is the money that's left over after the business invests in initiatives like supply chain enhancements or store development to fuel growth.
The company doesn't pay a dividend. But management has been focused on sizable share repurchases in recent quarters. In the past nine months, Lululemon spent $1.3 billion to buy back its stock, with a fresh $1 billion authorization just added. Consequently, this helped to make the current share count more than 3% lower than it was a year ago.
Investors should appreciate this move because it demonstrates management's adeptness at making the right capital allocation decisions when market conditions warrant. Shares hit an all-time high in December last year, after which they have fallen 23%. Likely influenced by the cheaper valuation, management took advantage of this to benefit shareholders.
If you have Lululemon on your watch list, you now understand the brand's premium status, domestic growth struggles, and management's capital allocation. In my opinion, the positive factors outweigh the negative, so the stock should be considered as an addition to your portfolio right now.
