The $53 Billion Athleisure Business

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Hey Friends,

Lululemon has continued to ride the athleisure wave throughout the pandemic.

Last week, the athletic apparel retailer posted strong fiscal third-quarter earnings, with earnings per share and overall revenue comfortably beating expectations.

• Earnings per share: $1.62 adjusted vs. $1.41 expected

• Revenue: $1.45 billion vs. $1.41 billion expected

The company also opened 18 new company-operated stores, watched its goss margins increase 110 basis points to 57.2%, and masterfully threaded the needle on inventory management throughout the quarter.

The result is one of the best-performing retail stocks over the last five years.

$LULU Performance

• 1-year: +15%

• 2-year: +76%

• 3-year: +250%

• 4-year:: +414%

But that’s only part of the story.

Despite increasing gross margins, maintaining appropriate inventory levels, opening new stores, and beating EPS & revenue estimates, Lululemon still watched its stock drop ~2% after its earnings call.

That’s because the company lowered guidance for its connected fitness device, Mirror.

Lululemon acquired the nearly invisible interactive home fitness product in June 2020 for $500 million and boasted about its plan to integrate it within owned-marketing channels, increasing sales and creating a powerful moat that competitors couldn’t crack.

The company saw initial success with this strategy, beating their estimate of $100 million in Mirror sales by roughly $75 million last year. But similar to Peloton’s turbulent year surged by the pandemic, Lululemon appears to be coming to terms with the headwinds facing the digital fitness market.

The company was expected to increase sales from $175 million in 2020 to between $250 million & $275 million this year, but that number has now been revised to $125 million to $130 million.

Yes, you read that right; after initially estimating that Mirror sales would almost double year-over-year, Lululemon now says that they expect sales to decline by about 25% year-over-year.

"As you know, 2021 has been a challenging year for digital fitness. And as I mentioned on our last earnings call, we have seen increasing pressures on CAC [customer acquisition cost] that are impacting the entire industry," CEO Calvin McDonald said on the company's earnings call.

The good news is that Mirror represents just 3% of Lululemon’s overall revenue, and virtually every other important financial metric is showing strong growth.

Men’s sales are up 24%. Women’s sales are up 29%. Digital sales are up 23%. China sales are up 70%. Europe sales are up 20%. DTC now represents over 40% of the business. Gross Margins have increased 110 bps to 57.2%. Inventory levels are manageable despite supply chain issues, and the company is growing at a 2-year compounded annual growth rate of nearly 30%.

I could go on, but you get the point. The velocity of money right now is wild. The government has injected trillions of dollars into the economy, increasing the money supply and driving inflation to levels we haven’t seen in nearly 40 years.

Combine that increase in fiscal stimulus with lockdowns that resulted in people turning to at-home fitness, and you had rocket fuel for Lululemon.

Now, they’ll have to show us that they can build a sustainable moat and that the $500 million Mirror acquisition won’t turn into a cash-burning rabbit hole.

I hope everyone has a great day, and we’ll talk tomorrow.

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