Why “Affordable Luxury” Doesn't Compound
Programming Note: MBI Deep Dives will be off during the weekend and I will resume the daily posting cadence from Monday next week.
Even though I sold my Lululemon position last year, I have to admit I don’t quite feel much relief for avoiding the 50% drawdown experienced this year. If anything, Lulu’s dismal performance is a source of embarrassment for me. The stock today trades around $100 and I was quite bullish when it was trading above $300 a couple of years ago! It’s hard not to feel at least a tinge of embarrassment when you are off by such a large margin! And no, it’s not just stock market being wildly wayward on sentiment alone; there is perhaps no business I was ever more wrong about than Lululemon.
While I don’t follow Lulu closely anymore, I was shocked when I opened their earnings press release a couple of weeks ago. I clearly didn’t imagine the business would experience negative growth in almost all possible segments. Even within international segment which was the sole positive contributor to revenue growth, revenue from China Mainland (which is the largest chunk of international revenue) actually also declined by 2% once you adjust for FX.
In retrospect, I tried to fight the “retail is hard” consensus crowd, and I guess I have to concede that there was more wisdom in that consensus than I appreciated. The moats that I imagined Lulu had turned out to be quite a bit fragile. I thought instead of relying on global superstar athletes, Lulu’s strategy of using local ambassadors to promote their brand would prove to be quite a sustainable way to grow the business over time. Unfortunately, in the age of algorithmic social media, you can buy influence at a relatively cheap price which has only intensified competition over the last few years. Moreover, I have also started to internalize a more fundamental tension around compounding in “affordable luxury” segment. For example, I have spent probably around $1k last year on buying various Lulu products. It’s just hard to imagine that my own spending on Lulu products will compound over time. While there are certainly Lulu addicts out there, perhaps only a small segment of people actually want their wardrobe to be completely dominated by one brand. As a result, the key source of long-term compounding here needs to be driven by widening the customer base. But by its very nature, in fashion the more mainstream a brand becomes, the more likely it becomes that the brand loses its appeal among the OG addicts. These can still be very good businesses but multiple decades of compounding especially when the brand is well past the early part of the S-curve just seems very, very difficult. It’s possible, but such an outcome would be an anomaly. Of course, many investors probably already figured these out before I have learned the hard lessons after paying exorbitant tuition.
What gives me bit of a pause amidst this self-flagellation is Lulu’s current woes seem to be much more widespread in branded apparel and footwear land. Both Lululemon and Nike are down 80% from their respective peak a couple of years ago. Even Adidas and Deckers experienced 50-60% drawdown.
Even within this group, Nike still looks optically much more expensive despite the whopping 80% drawdown. Lulu, Adidas, and Deckers are all trading now at low double digit NTM P/E multiples whereas Nike is still trading at ~22x P/E. So even though it may not feel like it, but if anything, investors are likely exhibiting a lot of patience with Nike. Perhaps investors think Nike is already closer to trough earnings whereas the rest still have to travel a bit longer before reaching the trough.
I asked Claude to show me annual revenue of Lulu, Nike, Adidas, and Deckers in 2015, 2019, 2023, and on LTM basis. As you can see below, it is only Nike within this group that experienced revenue decline LTM compared to their respective revenue in FY2023. It’s also quite revealing to observe just how anomalous the 2019-2023 period seems in hindsight. Lulu added only ~$2 Billion incremental revenue in 2019 vs 2015, but added almost $6 Billion incremental revenue during 2019-2023 period. Post-covid spending splurge on consumer goods propelled these businesses so much that it misled investors like me thinking much of this growth had more secular forces behind such as athleisure, and DTC. But as consumers moved more of their spending to experiences, and other macro forces such as inflation, interest rates, rise of dupes, and tariffs played their roles, these businesses now appear to be much shakier. It also doesn’t help that China, which is supposed to be growth driver, has been turning out to be a drag instead.
While Lulu is trading at a cheap multiple today, I cannot say I feel enticed by it. I was actually wondering if consumer agents are the latest headwind for these businesses. These consumer agents will be exceptionally capable of finding discount codes, and may nudge consumers more to long-tail brands than mainstream ones especially if Shopify’s catalog becomes their first pass before deciding to spend compute for browsing the open web. “Too hard pile” is perhaps indeed where branded apparel belongs if you intend to invest for the long-term.
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Please note that these are NOT my recommendation to buy/sell these securities, but just disclosure from my end so that you can assess potential biases that I may have because of my own personal portfolio holdings. Always consider my write-up my personal investing journal and never forget my objectives, risk tolerance, and constraints may have no resemblance to yours.
I have made a couple of changes to my portfolio yesterday.