Consumer Sector Market Commentary

Lululemon Thesis Update:

At the time of writing this - Lululemon is currently trading around $334, $30 away from my bearish price target of $304. Since our last report on them, the stock has had a drop of 12.57%. We believe this drop reflects a combination of factors including overall macro sentiment which has led XLY (Consumer Discretionary S&P Sector ETF) down 9% on the year. One thing we want to make sure to point out is that our view is completely idiosyncratic and not a play on tariffs and/or other macroeconomic factors - Lulu produces nearly 90% of its products in Vietnam, Cambodia, Sri Lanka, Indonesia, and Bangladesh.

Reiterating our thesis, we believe that Q1 earnings are when Lululemon stock will re-rate. Although the stock is running up heading into earnings this Thursday, we see management guiding down comparable sales in the US and we still see 2025 yearly revenue estimates as overly optimistic. We still see China being a cash cow for them but not being able to fully make up for the losses in the US. CEO Calvin McDonald recently stated, “Currently we have around 700 stores, but that should be easily over a 1,000 as we double sales.” This will be the fundamental long-term bet you are making when Investing in Lululemon stock, and there’s no chance that this will happen with the expansion we are seeing from Alo and Vuori.

Looking at the graphic from the VIC long Lulu pitch above, we see that Lulu has a super loyal customer base and this is giving bulls hope that the product spill in mid-2024 won’t be a long-term problem. Bullish investors have hope for better product assortment releases in 2025 but we don’t see product assortment bringing back the lost customers who switched to other brands. Lululemon’s management has sacrificed quality for more bps of margin and when reading reviews online you get the sense that this started in 2018-2019, here are some quotes via Reddit;

“Things I bought 10 years ago look brand new. Things I bought a few months ago have crooked hems, messed up stitching, size inconsistency.” - rossiloveyou

“They sacrificed quality big time around 2018/2019. All of my THE Shorts are from before that time period and I still wear all of them to this day, all of them in top notch shape still. They moved towards cheaper material which are not as comfortable.” - soccerfan12670

The vibe you get from reading these is that Lululemon has lost its identity along the way of growing into a $40 billion brand.

While we’ll see some headwinds from holiday sales in these Q4 sales, Lululemon is a short going into Q1 2025 earnings in our opinion.

Consumer Sector Update By Paro Chaudhuri;

A sector that I'm sure is on everyone's mind right is now consumer and retail. With the Fed staying put, consumer spending is staying stagnant although reports of cutting back and borrowing costs stay stable. Consumers are looking for value but aren't necessarily cutting back just yet, even with talks about a recession, especially in uncertain times like now. Retail sales in the U.S. increased by just 0.2% in February falling short of the the expected 0.6%. YTD, retail sales grew by only 1.5%, marking one of the slowest paces in the American economy in the past 12 months. This slowdown fact-checks the idea that while consumer spending hasn’t fully rolled back, it is stagnating. With credit card defaults ticking higher and the savings rates still being below historical averages, discretionary purchases are at risk of further weakening. Retailers like Walmart and Target have already said that consumers are looking to prioritize essentials and actively seeking promotions and discounts, a trend likely to stay common throughout the year. Key categories show a clear divide in consumer behavior. Spending at restaurants, fast-food chains, and bars was up nearly 0.4%, reflecting continued demand for dining out, while grocery store sales rose only 0.1%, likely due to food price inflation rather than increased consumption. General merchandise stores saw a 0.5% gain, while clothing and accessories stores fell 0.3%, suggesting a pullback in non-essential items. Online sales, a huge driver of retail, grew just 0.2%, the weakest gain it has had in several months.

One stock that I find is stuck in the mud is General Mills ($GIS). As I mentioned above consumers are scaling back on non-essential pleasure items like pop-tarts and cigarettes, and with talks about a benefit reduction to food stamps, doesn't look like it's going to get better any time soon. It's already down -4.6% in the last 5 days. It returned -7.8% over the last YTD. Their EPS is also set to decrease from $4.19 to $4.12 over the FY 2025-26. I think consumers will keep on cutting back over this year. It's just how it is. Nothing we can do. Even for myself, I walk into a store, and a snack that used to be a dollar is now 1.99. It's not much to the naked eye but it just makes you a bit pissed off. Tariffs are not helping $GIS and their industry. I read an article that said Canada is charging a fee for trucks entering from the PNW to go to Alaska. But since You have to go into Canada to go into Alaska, it makes it harder to get products up there.

Inversely one stock that I do like and I think is undervalued is Restaurant Brands International ($QSR). If you have ever had Popeyes or Burger King, that's $QSR. Income-focused investors love this company due to their dividend-paying focus over the years. The yield is currently a little over 3%. Their dividend payouts have increased every year over the past 10. They beat their Q1 estimates this past February. Their EPS is also set to increase from $3.73 to $4.06. Sales also look to be on the rise, with analysts predicting sales to rise from $9.26B to $9.59B in the next FY. What I think is the protective shield for $QSR is the consumer wants factor. May not be cheaper per ingredient, but it is more convenient than cooking food at home and cleaning up. You eat the food, enjoy the flavors, throw the wrapper away, and go on about your day. Burger King recently brought out the $5 duos and $7 trios, which allows customers to mix and match order items. This has seen a good amount of success. Popeyes also brought out a new flavor of wings, Louisiana garlic wings. As a wing enthusiast myself, I can tell you it's damn good. To end, I think consumer spending as a whole is going to retreat given the uncertain market conditions, but it’s important to look at the micro-sectors. Pleasure items like Pop-Tarts, cigarettes, and chips are likely to see a decline in sales as consumers become more selective. On the other hand, fast food remains a staple for many even me, offering convenience at a time when grocery prices are still high. $QSR is adapting well with value-driven deals offered through their burger king chains. Popeyes is also keeping consumers engaged with new menu offerings, further proving that product innovation will help maintain demand even in a softer spending environment. While overall retail sales growth is slowing, the key takeaway I see in all of this is that spending isn’t disappearing—it’s just shifting. The companies that understand where consumers are prioritizing their dollars and adjust accordingly will be the ones that hold up best. The ones that don't, will fall under.