Why Lululemon’s 2019 Profits Should Have Grown Nearly 30% Despite A Sharp Increase In Expenses

by Trefis Team
Lululemon Athletica
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Lululemon Athletica Inc. (NASDAQ: LULU) has achieved robust growth over 2015-18, with the company’s revenue increasing a whopping 59%. But the apparel company’s expenses following a similar trend over this period – resulting in profits remaining broadly level. While Lululemon is likely to report strong revenue growth of 19% in FY 2019 too, expenses should grow at a slower pace (17%). This should result in Lululemon’s earnings margin (i.e., revenues less all expenses, expressed as a percentage of revenues) expanding by 110 basis points from 14.7% in 2018 to an expected 15.8% in 2019 – resulting in an increase of 28% in Lululemon’s net income for the year. Trefis breaks down the company’s major expense components in its interactive dashboard, ‘How Does Lululemon Spend Its Money?‘ parts of which are summarized below.

Notably, operating expenses (which include selling, general and administrative expenses (SG&A), and other management costs) are expected to be $1.3 billion in FY 2019 – making up 40% of Lululemon’s $3.3 billion in total expenses for the year. Lululemon’s operating costs are 75% of the company’s most significant expense driver – its manufacturing costs or the cost of sales (COGS).

  • Lululemon’s total expenses have increased by 56% since 2015, going up from $1.8 billion to $2.8 billion in 2018 and are expected to grow another 17% in 2019. Operating expenses have been the single biggest contributor to this increase, as they swelled from $628 million in 2015 to more than $1.1 billion in 2018.
  • The company is expected to add $480 million to total expenses in dollar terms in 2019, likely to be driven by a $270 million increase in the cost of sales.
  • However, the company’s total expenses as % revenue are projected to decrease by 110 basis points, from 85.3% in 2018 to 84.2% in 2019.

Cost Of Sales

  • The cost of sales includes the expenses incurred to acquire and produce an inventory for sale, including product costs, freight-in, and rent & occupancy costs for company-operated stores. COGS is the most significant expense driver, accounting for nearly half of the company’s total expenses in 2018.
  • COGS have increased by 38.4% over the last few years – rising from $1.1 billion in 2015 to $1.46 billion in 2018 primarily as a result of strong revenue growth.
  • Higher revenues, lower product costs, a favorable mix of higher-margin products, and lower markdowns have helped Lululemon’s gross margin expand by 680 basis points over the same period. Moreover, a decrease in occupancy and depreciation costs as % of revenue have also aided in the gross margin expansion.
  • We expect COGS to grow by 18.3% in 2019, which represents a gross margin figure of 55.4%.

Operating Expenses

  • Lululemon’s operating expenses have increased 77% since 2015, increasing from $628 million to $1.1 billion in 2018, led by an increase in operating channels, as well as an increase in the head office costs.
  • Additionally, operating expenses as % of revenues are also on the rise – increasing from 30.5% in 2015 to nearly 33.8% in 2018. This metric increased to 35.6% in 2017 due to asset & impairment restructuring charges of $38.5 million incurred in connection with the restructuring of the company’s ivivva operations.
  • We expect total operating expenses to increase by 18% to cross $1.8 billion in 2019, representing 33.6% of Lululemon’s Total Revenues of $3.9 billion.

Non-Operating Expense (Income)

  • Lululemon’s non-operating expenses have decreased from $1 million in 2015 to -$9 million in 2018, mainly due to higher interest income, partially offset by higher interest expense.

Additional details about how Lululemon’s Non-Operating Expense has trended over the years are available in our interactive dashboard.

Income Taxes

  • Lululemon’s income tax expense has steadily increased over the last few years, going up from $102 million in 2015 to around $231 million in 2018. The tax rate figure was unusually high in 2017, mainly due to an additional provisional income tax expense of $58.9 million incurred due to the enactment of the US Tax reform.
  • The effective tax rate is expected to be around 28% in FY 2019.

Per Trefis estimates, Lulelemon’s EPS for fiscal 2019 is likely to be $4.75. Taken together with a P/E of 48x, this works to a fair value of $228 for Lululemon’s stock, which is roughly 5% behind the current market price.

See all Trefis Price Estimates and Download Trefis Data here

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