Lululemon Athletica Beats 2018 Consensus; Investors Upbeat After The New Share Buyback Announcement

Lululemon Athletica Inc. (NASDAQ: LULU), the Canadian athletic apparel retailer, announced its Q4 2018 results on March 27, 2019, followed by a conference call with analysts. The company beat market expectations for revenues and earnings for the quarter. LULU reported revenues of $1.2 billion in Q4 2018, 25.7% higher than in the year-ago period, whereas for the full year, revenue increased by 24.1% to $3.3 billion in 2018 from $2.6 billion in 2017. Higher revenue was mainly driven by the opening of 36 net new branded company-operated stores since Q4 2017, a comparable store sales growth of 7%, a whopping increase of 48.7% in direct to consumer (digital) revenues due to increased traffic and better conversion rates, and over 9% growth in the company’s wholesale business. Earnings for the fourth quarter came in at $1.85 per share, much higher than $1.33 in Q4 2017, whereas for the full year earnings almost doubled to $3.63 per share in 2018. Higher earnings were driven by lower product costs, favorable mix of higher margin products, and the absence of any restructuring charges ($38.5 million restructuring charge related to ivivva operations recorded in 2017).

We have summarized the key takeaways from the announcement and our outlook for Lululemon in our interactive dashboard – How did Lululemon Athletica fare in 2018 and what is the outlook? In addition, here is more Trefis Consumer Discretionary Services data.

Key Factors Affecting Earnings

Higher digital growth: Direct to consumer segment is the fastest growing segment of the company. Revenues for this segment increased by an impressive 48.7% to $858.9 million in 2018 from $577.6 million in 2017. The increase in revenue was primarily the result of increased traffic on LULU’s e-commerce websites, improved conversion rates, and increased dollar value per transaction. Digital sales increased its contribution to 26.1% of total revenue from 21.8% in 2017. With increased digitization, higher traffic on the company’s website and mobile apps, along with the recent improvement in conversion rates, we expect the segment to continue its healthy growth rate along with a further rise in the share of digital sales to over 28% in 2019.

Retail store business: Though almost 80% of the company’s stores are located in North America, LULU has recently made efforts to increase its presence in emerging markets like China, where the store count has increased from 15 to 22 in a year. Further, it has shut down a number of its less successful ivivva brand stores and replaced them with regular stores in the U.S. All these strategies are expected to benefit the segment in the near future. Retail store sales contributes the largest share to the company’s revenues. Along with comparable store sales growth of 7% in 2018, the company opened 36 net new company-operated stores, including 15 stores in North America, 13 stores in Asia Pacific, and eight stores in Europe, which led to a 15.7% growth in segment revenue, mainly driven by increasing consumer traffic and improving conversion rates. Though the segment is expected to continue to stay on the growth path, we believe that with the tremendous growth in digital penetration and online traffic, growth in retail store revenue would remain subdued at close to 9%-11% going forward, bringing the share of the segment to total revenues down at close to 60% over the next two years, from the current level of 65%.

Improving profitability: LULU’s net income margin increased from 9.8% in 2017 to 14.7% in 2018. During the previous year, LULU shut down a number of its less successful ivivva brand stores, which led to the company incurring $38.5 million of impairment/restructuring charges. However, in the absence of any restructuring charge during 2018, the company’s margins received a boost. Additionally, margin growth was also driven by an increase in product margin of 170 basis points, which was primarily due to lower product costs and a favorable mix of higher margin product, and lower markdowns. However, these benefits were partially offset by higher employee costs, primarily driven by growth in labor hours and benefits, mainly associated with new company-operated stores and other new operating locations, and due to higher retail bonus expenses, coupled with 15% increase in tax expense due to a one-time transition tax following the implementation of the TCJ Act.

What Lies Ahead?

In June 2018, LULU’s management increased the company’s existing $200 million share repurchase program to $600 million. Further, along with its Q4 results, the company announced an additional stock repurchase program for up to $500 million, post which the stock price increased by over 15% in a day. Though the Trefis price estimate of $163 per share for LULU’s stock is higher than the earlier estimate, it is still lower than the stock’s current market price of approximately $167. We believe that impressive revenue growth trends, aggressive expansion of its digital ecosystem, strong same-store sales growth, focus on high margin brands and rising profitability, coupled with increasing focus on enhancing shareholder returns through buybacks, would likely provide support to LULU’s stock price going forward. However, we expect a small correction in the share price from its current levels which were reached due to the initial euphoria around the additional buyback announcement.

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