Key Points:
- Given LULU’s 10.5X P/E ahead of earnings, expectations were low, but not for a -20% earnings guide revision (wow-za!). But given that it’s Friday of Labor Day weekend, any stock reaction was bound to be exaggerated.
- A worse outlook for Q3 (vs. Q2’s trend) was also a large negative sentiment impact.
- From the results in the athletic space, most notably DKS, we know that the overall footwear and apparel category has too much inventory relative to demand, and that athleisure demand has waned in favor of denim and dressier brands. That imbalance certainly impacted Lulu’s average ticket, gross profit rate, and profits.
- Industry-wide high promotions and clearance events in the online channel and ample product availability in the off-price channel are also current headwinds to brand store traffic and sales.
- Underlying store traffic was better than what Americas comp (-12%) implies given our deconstruction of the figure; we estimate that store comp-traffic was down slightly.
- Incoming CEO Heidi O'Neill certainly faces many large challenges. Sitting management is doing its best to make it easier for her. To what level does O’Neill need to rebase the business? Give us a call for our opinion.
The deterioration in Lulu’s US business has been remarkable and that creates a lot of mystery, questions, and stakeholder concern. From the past two earnings calls (and the preceding several years of results), our view is that a lot of the 2020, and onward, sales growth came from 1-offs and non-sustainable tactics to push revenue higher rather than revenue being pulled higher by strong underlying and sustained consumer demand (the dynamic prior to the pandemic). Growth after 2020 was particularly challenging because of the Covid-year’s 40% growth (+$1.5B), which lifted the revenue base to an abnormal height. (We’re just talking about the America’s region here; China is another +/-story.) Push-led businesses typically reach a non-sustainable top, resulting in a reset.
1-offs are things like some of the accessories and bags. Non-sustainable could be tactics like pushing the product mix (average price point) too high, etc. The heavy reliance on influencers (who are fickle) and bottom-of-the-funnel marketing are others. And so, that’s why we were struck by Interim Co-CEO and President Andre Maestrini statement, “We are also making the appropriate decision to strengthen our foundation and drive more sustainable growth over the medium and long term.” Said differently, Lulu is walking back from the non-sustainable and 1-offs and shrinking to grow again on a more solid foundation (see the -15% SKU reduction initiative). The reset certainly fosters concern about the brand health. We think, and our data supports, that consumer interest in the brand is better than Wall Street perceives or what a -12% Americas comp decline suggests. Lastly, outsized growth invites competition, and this was certainly the case with Lulu, who invited Alo, Vuori, Athleta, FP Movement, etc into the category. (That’s how you get something like Lulu’s women’s leggings category declining 20% for the quarter.)
The FQ3 guidance for US revenue to decline 15% suggests that Lulu is trying to deflate the revenue base and clear inventory to create a cleaner base for incoming CEO Heidi O'Neill’s start from. Management said that traffic slowed further in August (-200bps in our data); some of that slowdown in the later back-to-college season given Labor Day’s timing; traffic for August to our Retail REITs index is -230bps softer than Q2. In terms of the timing of O’Neill’s announced turnaround plan, if we were a Kalshi speculator, we’d bet on ICR in January. Product for the 2H is already being produced in the plant, on the boat, or in the warehouses. We expect O’Neill’s plan to principally focus on the assortment, especially opening price points, and marketing. We’d be surprised if the plan included store closures in the Americas; we’d also be surprised if the plan included an increase in the region’s store count.
In terms of brand and marketing, CFO Meghan Frank said, “I would say given the challenges we've seen with -- from both the brand heat and product perspective- we do feel strongly that we need to continue to keep our investment level in marketing. I would say we're looking at more mid-funnel, top-of-funnel activations, community engagement, things such as what I've mentioned in terms of… summer series, going after fall marathon season, our U.S. Open activation, the content series as well as social. So it's definitely brand building marketing efforts.” (Yep, shifting the marketing mix from the bottom of the funnel, upwards. They need to restore organic demand.)
Lulu’s America’s comp decline of 12% can be broken down as follows:
- Canada worse, putting the US at -11%.
- US online at -18% (per Advan’s data), putting the US stores comp-sales at around -6%.
- US stores average ticket at -5% (per Advan’s data), putting comp-transactions at -1%-ish.
- Store comp-traffic slightly negative with locations in urban canyons and indoor malls (60% of the store base) at down slightly (-2-3% per Advan’s math) and +2.4% for locations that are geo-fencible (our data).
- The conversion rate dropped, which resulted in the slightly negative traffic yielding -1%-ish comp-trans.
A few comments on the figures:
- The 18% decline in online is certainly stark, but it’s a market dynamic also described by Dick’s Sporting Goods -- brands across the board have too much inventory and they are clearing it out using deep clearance prices in their online channel and off-price channels (yes, Lulu too per the 10-Q). (See the snip on the next page and the response to the query “Alo clearance”, Lulu’s the brand showing up). Contributing to the softer category demand is the consumer fashion trend shift from athleisure to more dressy - classy and “brown shoe.” See Macy’s CEO making note of the shift on its FQ3’25 earnings call – “[The] consumer is investing into dresses and career sportswear and our contemporary collections and denim, so other kind of active-ish casual categories, just not active-wear.”
- The stores’ average ticket’s decline of -5% suggests that Lulu is working to clear out all the 1-offs and style misses, and turn up the inventory. Despite the deep sales decline in what is a seasonal smaller period for the business, inventory turns actually increased nicely to 3.0X vs. 2.5X last year and 2.7X in FQ1. On a unit basis, the improvement was even greater.
- The 10-Q notes that traffic declined, but it doesn’t say by channel. The 10-Q also notes that conversion rate declined. And so, the decline in comp-traffic was less than -transactions. The more moderate decline tells us that the consumer remains interested and engaged with the brand; however, when they visit the stores, they aren’t delighted by the merchandise (and price-points), and so the traffic doesn’t convert into sales. This suggests that Lulu’ problem with merchandise and price positioning is more acute than any “brand” problem. Obviously, if left as is, the poor merchandise impression will impact the brand.
- On the conversion rate and product, Meghan Frank said, “We continue to learn from what's working, not working, reordering aggressively into what is working.” i.e. their assortment plan was wrong.
- Out-of-stocks may have also contributed to the conversion rate decline, and so, there should be legitimate questions about supply chain and operational execution.
