Lululemon Investment Thesis; Short $LULU Into Q1 2025 Earnings

I recently submitted this idea for a stock pitch competition, you can view the Equity Research report I created below, but I’ll lay it out also.

I think it’s worth your time to check out the PDF as it includes all of the graphics and charts that support my thesis.

2024 performance of Lululemon (Blue), benchmarked against SPY (Purple) and XLY (Orange).

Overview (As of Jan 1, 2025)

Price: $382.41

Rating: SELL

Price Target: $304.58

52 Week Range: $226.01-$508.92

Market Cap: $46.57 Billion

NTM P/E: 25.6x

At a Crossroads: Growth Uncertainty

In the past 6 months, Lululemon has run up 23% from yearly lows because investors think that competition among companies in the Athleisure market is a short-term conflict that is driving down their domestic sales but that is not true. I believe that US growth is not gonna be stabilizing any time soon and the brand's lack of product innovation is eroding away their pricing power. This is reflected in the growing resistance of consumers paying full price and a redirection of consumer attention toward "fresher" and more dynamic brands like Alo and Vuori. Lululemon has also started to explore products in different sub-sectors, this search for a second curve of growth is a mixed signal that questions their outlook for their major product lines. Historically what has moved the stock is domestic sales and it’s been a rough year for Lulu in terms of same-store sales growth in the Americas. In response to this, the company has turned to China for growth which has made investors happy but I don’t think this trend is sustainable. My differentiated view is outlined in the thesis points below:

Thesis #1: Competition in the Activewear Market -> Slow-down in US Market

Since 2023, US-based brands Alo and Vuori have each gained a 1% market share in the activewear space. These DTC brands have stood out due to the low barriers to entry in the market. Alo launched an interactive app on the Apple Vision Pro and partnered with former Lululemon enthusiasts Kylie and Kendall Jenner, while Vuori recently raised $825 million at a $5.5 billion valuation from General Atlantic and Stripes.

In November, activewear sales were down 14% year-over-year, continuing an ongoing market trend. Lululemon finds itself in a tough position, where I see one of two outcomes: either the activewear market experiences a rebound, which seems unlikely given shifting fashion trends, or Lululemon's earnings begin to erode. We're already seeing signs of this, as in Q3, Lululemon reported a 2% decline in US comparable sales and only a 4% increase in comparable sales. Investors and management have begun to give Lululemon a pass, overlooking the pressures from increasing competition and a challenging macro environment for consumers. However, I anticipate that 2025 will be the year when Lululemon’s stock price more accurately reflects these market dynamics, as the cannibalization of its customer base continues to intensify. I modeled in revenue of 10.9 billion in 2025 due to this, where the street has a consensus estimate of $11.27 billion.

Thesis #2: All Roads Lead to Margin Pressure

Lululemon’s pricing power has supported a 59% gross margin, 11% above the industry average, but I believe this edge is under pressure as consumers resist paying full price. The brand has faced setbacks this year, including a July recall of its “Breezethrough” leggings due to design flaws, compounded by the departure of Chief Product Officer Sun Choe, which sent shares into a frenzy. Customers have also criticized Lulu’s limited color options, prompting many to explore brands with broader and more affordable offerings. While addressing these issues may seem straightforward, once consumers shift to cheaper alternatives with more variety, winning them back could not be easy.

Lulu has been searching for a second curve of growth in footwear and golf, where it risks competing with major established brands such as Nike. This is a strategy often seen in struggling brands such as Under Armour. Under Armour initially thrived in the indoor fitness segment but struggled after 2013 as competition, particularly from Lulu and Nike, intensified. Its attempt to find a second curve of growth through a female-focused strategy and diversification into sub-sectors like yoga, skiing, and golf provided only temporary relief, ultimately failing to sustain meaningful revenue growth. Under Armour’s revenue was down 11% this past quarter.

Lululemon management has guided marketing spend at 5.5% of sales this year, but I expect it to rise to 8–10% as they compete in larger markets. This will pressure net income margins, while pricing power challenges could further erode gross margins. I have modeled gross margins compressing toward 52%. For Q4, Lulu forecasts a 20–30 bps year-over-year gross margin decline, a trend I anticipate continuing. Combined with rising competition and increased investment needs, margins could approach toward the industry average of 45–50%.

Catalyst: Earnings (Q1 ’25)

My hard catalyst is Lululemon’s fiscal 2025 Q1 earnings, where I expect a revenue miss on the $2.39 billion consensus and lower full-year guidance. Management has blamed inventory issues and macroeconomic challenges for declining sales, but with a better economic environment ahead, those excuses won’t hold up. I believe they’ll also signal weaker comparable sales in the U.S. as competition ramps up and the downward trend continues. The stock currently trades around a 26x forward P/E, but after earnings, I foresee it dropping to a more reasonable 17x–22x range as investors recalibrate their expectations.

Company Overview:

Lululemon Athletica Inc. is a premium athletic apparel and accessories company that has successfully transformed from a yoga-centric brand into a global lifestyle and performance wear powerhouse. Founded in 1998 in Vancouver, Canada, the company has leveraged its vertical integration model, brand authenticity, and community-based marketing to capture a significant share of the activewear market. The company currently operates 749 stores worldwide and in 2023 made 79% of its revenue from the Americas, 10% from China, and the rest from other areas.

Risk #1: International Expansion

Lululemon’s growing global presence could drive stronger-than-expected top-line growth. In Q3, international sales rose 33%, with 39% growth in Mainland China, supported by the Healthy China 2030 initiative. Since its first Chinese store in 2014, Lululemon has expanded to 138 stores in the region and 300 stores across 26 markets globally. If future investment in international markets is higher than anticipated, revenue could be higher than estimated.

However, competitors aren’t just sitting back and relaxing. Alo recently tapped a former Arc’teryx executive to lead its Chinese expansion, with Arc’teryx deriving 44% of its $1.5B revenue from Greater China. Vuori, branded in Shanghai as “Lululemon for men,” aims to open 100+ stores internationally by 2026. Maintaining its lead will require innovation and strategic execution from Lululemon in this competitive landscape.

Risk #2: Potential for Activist Pressure

Lululemon has repurchased $1.4 billion in shares year-to-date and is authorized to buy back an additional $2 billion. The company holds $1.2 billion in cash with no long-term debt. However, with performance lagging, there’s a risk of an activist investor stepping in. An activist could push for increased shareholder returns through additional buybacks or even the introduction of a dividend, which could drive up the stock price.

That said, one factor diminishes this likelihood: CEO Calvin McDonald. Known for his resistance to criticism, even from founder Chip Wilson, McDonald appears unwilling to yield. In March, Wilson accused McDonald of lacking vision and turning the brand into “The Gap,” citing sacrificed quality for margins. McDonald responded bluntly, stating, “Chip Wilson does not speak for Lululemon – period.”

Since it seems McDonald would rather sacrifice billions in market cap just to prove he’s “right” than make the necessary changes, I don’t see any room for an activist as long as he’s at the helm.

Valuation

My EBITDA multiple of 9x reflects the industry average derived from comparable companies (See Exhibit 4 in PDF). This marks a re-rating from Lulu’s current multiple of 14.4x, resulting in an equity value of $37 billion. I have modeled a shift in sales composition, with the Americas declining to 66% and China increasing to 19% of total revenue by 2030. Using a DCF model, I derived a target price of $304, assuming revenue growth moderates to 5% annually and gross margins compress toward 52%. At the current price of $382, my target price of $304 represents a 20% downside, highlighting an unfavorable risk/reward profile for long investors.

Final Thoughts

Despite the recent uptick following Q3 earnings, Lululemon faces a tough road ahead. Comparable sales in the U.S. have struggled and have turned negative, while competitors in the activewear market are catching up. This suggests that yearly and quarterly 2025 revenue estimates are overly optimistic, and I expect management to revise their guidance downward. I anticipate ongoing margin pressure and declining same-store sales in the U.S., with first-quarter 2025 earnings serving as the catalyst for the stock to reach its intrinsic value of $304.

Cheers to the new year - If you have questions about the pitch, you can shoot me an email - [email protected]