Lululemon (LULU -4.92%) has been a fantastic investment. In the past decade, shares have skyrocketed 599%. This gain crushes the broader Nasdaq Composite Index.
However, this apparel stock is trading 39% below its December 2023 peak. Investors appear to be worried about slowing growth in the current macro environment.
Lululemon stock now looks like a smart buy on the dip. Before adding the company to your portfolio, though, learn about this one warning.
Competitive landscape
Finding lasting success in the apparel industry is extremely difficult. Companies must find ways to satisfy consumer preferences that are always changing. What's popular and fashionable one year might be completely forgotten the next year. Add in the fact that people have an unlimited number of clothing options to choose from, coupled with an industry that has almost no barriers to entry, and it's easy to have concerns.
As a result, the one warning investors can't ignore is the fact that Lululemon's brand might simply fall out of favor with consumers one day. Sales were up by 10% in the fiscal 2024 first quarter (ended April 28), compared to consistent high teens and greater than 20% growth in previous quarters. This might be a reason to worry that perhaps Lululemon's market position is weakening.
Lululemon also faces a ton of competition from both cheaper and more expensive alternatives. I don't think any industry observer would've accurately predicted that clothing brands like Vuori or Alo Yoga, for example, or shoe brands like Deckers' Hoka or On Holding, would become popular.
This means that there's always the risk that Lululemon's brand will fail to stay relevant in the long term, as it is under constant threat from peers who are all fighting for customer wallet share.
Reasons to be optimistic
It's always important for investors to understand any key risks that their businesses face. This helps round out one's knowledge about a company while at the same time helping an investor build greater conviction. But in this instance, I believe Lululemon deserves some credit.
For starters, management has shown it can develop and introduce new products that its customers will flock to, whether entering the footwear market or creating golf clothing for men. There's a clear focus on innovation, with the intention of catering to the various needs of its customer base.
Lululemon's distribution strategy must also be acknowledged. Whereas rivals rely heavily on wholesale retail partners, this business leans on its e-commerce channel and 711 company-operated physical stores to push its products. This controlled merchandising strategy gives management a better grip on product assortments and pricing changes while eliminating the need for Lululemon to give up margin to other retailers.
Nike, the juggernaut in the industry, has had to deal with inventory gluts and unusually high promotional activity and markdowns at points in the recent past. And when one of its third-party retailers has too much merchandise on hand, it's hard to know what pricing actions they can take without undermining the brand. To be clear, Lululemon isn't totally immune from this, but it does have tighter control on its sales pipeline.
This setup not only supports Lululemon's brand image, but it has resulted in tremendous profitability. In the latest quarter, the business reported a stellar 57.7% gross margin, which demonstrates its pricing power. Consumers wouldn't spend up on apparel if they believed Lululemon was selling something that wasn't differentiated in the marketplace.
The key objective, of course, is for the leadership team to do whatever they can to not lose this position. Given Lululemon's outstanding past success, investors should give them the benefit of the doubt.
