How Low Crude Oil Prices Are Good For Lululemon

Late last week, crude oil prices fell below the $60 per barrel mark for the first time in more than five years, putting downward pressure on the stocks of a number of businesses closely related to the energy sector. However, falling oil prices are not bad for all companies. Consider the case of yoga-based apparel manufacturer and distributor Lululemon Athletica (NASDAQ: LULU)

We have a $40 estimate for Lululemon, which is about 20% below the current market price.

A significant amount of Lululemon’s products are made from the company’s trademarked Luon fabric. ^[1] It is hard to estimate just how much of Lululemon’s product is Luon based with much precision, but in order to guess it is useful to consider the incident from 2013 when the company recalled its black Luon bottoms due to supply chain issues. Later, the company revealed that the product alone represented about 17% of all bottoms in its stores. ^[2] This does not even include other Luon-centric bottoms, tanks, tops, and jackets that the company also offers.

While the knit variety in which Luon appears in the finished product can vary from product to product, it’s comprised of 5/6th Nylon and 1/6th Lycra, both of which, at their bases, are derived from crude oil. ^[3] As a result, cheaper crude oil should translate into a cheaper cost of raw materials used in its products, implying a cheaper cost of goods sold and a higher gross profit. In this way, cheaper oil prices will have a direct positive impact on the company’s cash flows. They can also have an indirect impact on the company’s profitability as well: manufacturing the product is only one part of the business. The product also has to be transported to the company’s stores from its factories. A significant cost for any apparel based company is the cost incurred in the transportation of its products. A reduction in petrol, diesel, and gas prices should also translate into lower freight and transportation costs for the company. Additionally, a near 50% reduction in oil prices frees up more cash for consumers, who might decide to spend some of that cash on products like those of Lululemon.

However, lower oil prices will take some time to work their way through the complete supply chain and to the company’s bottom line. When that happens, they will, at the very least, serve to offset the significant investments the company has been making to improve its supply chain in the wake of last year’s product recall.

See our complete analysis for Lululemon Athletica here

Notes:

1. Lulemon Fabrics and Technologies: Luon, lululemon.com [↩]
2. Lululemon Too-Sheer Pants Recall Comes To An End, With Minimal Damage To Brand, Huffington Post, June 2013 [↩]
3. Here’s What’s So Special About Lululemon’s ‘Luon’ Fabric, Business Insider, March 2013 [↩]