John Hempton over at Bronto Capital Blog recently posted on Lululemon (Click here). After some discussion he asks the following questions.
So I want to play the valuation guessing game.
* What is the value of the end market for yoga and running clothes. Is it $5 billion per year at which point lulu will be priced like Nike or is it larger or smaller?
* Can you explain the stock price in any terms other than a play on female vanity? Is Kid Dynamite's explanation of the brand appeal and the stock right?
* Even as a play on female vanity is it overpriced?
* What if anything keeps the competition out of yoga clothes?
I thought I would take a few minutes to comment on the error that both John and many people make when trying to make sense Lululemon and the valuation.
First to call the company a retailer of yoga and running clothing would be the understatement of the year. I personally do not know one person who buys their clothing for yoga. Their products are top quality and most women live and die by the stuff (at least the ones that I know).
My wife has a few items from the company, but I try to steer her away because I hate paying the ridiculous prices. She does wear the Lululemon running shorts for working out, but that's it for athletic clothing. The rest of the clothes she owns, pants and tops, she wears for the brand, comfort and quality (in that order). And I must admit their clothes do look really good.
Among teenagers and young women the brand has a cult following here in Canada. Just go to any high school or university and you will see the product everywhere. If you want further proof just go to a store, especially at Christmas, it's a zoo.
Last year, when I was in Hawaii I went to the Lululemon store in Honolulu and the sales associates said the brand hasn't caught on over there yet. That said, I'm sure if you give it some time the brand will slowly grow and then explode in the USA just as it has in Canada.
So let me be clear, Lululemon is not a yoga clothing company. They are a turning into an iconic brand that has very large appeal among women.
For my American readers it is best to compare Lululemon to Under Armour. Both have around a billion dollars a year in sales, but Lululemon is superior in many ways. Under Armour sells mainly to men who will not pay any price for athletic clothing. Lululemon sells almost exclusively to women and who will pay up to be seen in the brand. Lululemon is also not just an athletic company, but predominately a fashion clothing line.
Looking back I really should have seen this company earlier as it is a classic Peter Lynch play.
As for competition, some companies have tried. You can imitate the clothing but you can't imitate to imitate the brand. The competition can only compete on price, but competing on price is really hard in this category. First it will force the company to compete with a lower quality product or accept razor thin margins. Secondly, competing on price is very difficult because of perceived value. Women in general believe that price equals value, especially when it comes to fashion. I mean, how many women want to be seen in a second class product unless they have very high self esteem.
This is the same reason why See's Candies (a subsidiary of Berkshire Hathaway) can sell more and more candy at higher and higher prices each year. Warren Buffett has said, they really guilt men into the higher priced product because they don't want to be perceived by their wives as being cheap. Imagine walking up to your wife and saying, "Here Honey, Happy Valentines Day! I settled for second best for you this year." That just isn't going to happen and it demonstrates the pricing power of the product. Lululemon has the same pricing power.
So what is the primary value in Lululemon? It really is a play on the vanity of women and the customer's desire to wear it and be seen in it. Basically it's for women who are fighting their battle with low self esteem, which includes almost every women in North American. So I see Lululemon as a play on human nature, which is really driving the brand appeal.
So what about valuation? I really don't understand it and can't make sense of it either, so it goes in the too hard pile. Simple as that. Obviously the female fashion market is much larger than yoga and athletic clothing, but guessing the ultimate market size isn't easy. On the other hand, I would be on the lookout for any negative stigma that may reverse the popularity of the brand. What is popular today can quickly change tomorrow.
Disclosure: Long BRK.B