Has Lululemon reached its peak?

Lululemon joined the ranks of the world’s most valuable retail brands on the back of Americans willing to splurge $120 on leggings. Now the purveyor of yogawear is itself splashing out, with a $500m cash deal for Mirror, an exercise equipment start-up.

The clothing company has long been pushing into different products, including menswear, and into territories outside its North American heartlands. But the move into workout hardware is among the clearest signs yet that its managers are turning to business lines to maintain Lululemon’s status as a Wall Street darling.

Calvin McDonald, Lululemon’s chief executive, said a boom in home fitness helped make Mirror — which sells interactive screens for $1,495 before tax and a monthly subscription — a “compelling” proposition. Still, the group’s first acquisition since it was founded 22 years ago, which is due to complete in the coming days, has brought to the fore perennial questions about whether its extraordinary organic growth has finally peaked.

“Lulu is showing no signs of slowing down, but acquisitions made outside a retailer’s core skill set have rarely been seamless,” said Simeon Siegel, managing director and senior retail analyst at BMO Capital Markets. “There is nothing bad about the story right now. The scariest thing [for investors] about Lulu is, is this as good as it gets?”

The New York-listed company has repeatedly defied doubters. Lululemon’s apparel, favoured by celebrities such as Meghan Markle, epitomises the enduring popularity of “athleisure”. In well-off neighbourhoods across the US and Canada before the coronavirus shutdown, Lululemon became as ubiquitous in coffee shops as in yoga studios, helping the company more than double annual revenues within five years to $4bn.

Line chart showing Lululemon share price and S&P index rebased

In stark contrast to the travails of other retailers, Lululemon’s shares have quintupled in the past three years, trouncing a 29 per cent gain in the S&P 500. Its market capitalisation has swelled to almost $40bn — about 10 times bigger than that of Under Armour, even though Lululemon has lower annual sales than its athleisure rival.

Despite its omnipresence on Main Street, the Lululemon brand has retained its cachet and the company has outperformed during the pandemic. Revenues fell 17 per cent year on year in the three months to May 3 as lockdowns forced the retailer to close stores, although Mr McDonald said a 68 per cent jump in online sales was evidence that the rise of homeworking was fuelling demand for comfortable clothing.

Meanwhile, Lululemon’s products, manufactured in countries including Vietnam, Cambodia and Sri Lanka, are among the most profitable in US retail. The company rarely offers discounts on its range of hoodies, sweatpants and sports bras, and its operating margins of 22 per cent in the last financial year were more than double those of Nike, according to Bloomberg data.

Bar chart showing operating margins of Lululemon and other athleisure and fashion groups, latest full year (%)

Bears fret that Lululemon will inevitably need to sacrifice its industry-beating margins to pursue growth. The company has been building the brand overseas, most aggressively in China, where it has about 40 stores. Recently launched products include its Selfcare deodorant, shampoo and beauty range. The company also plans to enter the footwear market.

Lululemon has had some success in turning stores into destinations — an elusive goal in retail — such as its 20,000 sq ft “experiential” store in Chicago, which offers yoga studios. However, Neil Saunders, managing director and retail analyst at GlobalData Retail, said coronavirus had forced the company to rein in ambitions to use its bricks and mortar spaces to create a wider Lululemon community. Those plans “may still be relevant further down the line, but essentially it’s had to be put on ice”.

The acquisition of Mirror, which offers online classes in pursuits ranging from barre to boxing, “allows them to take forward that vision of services, content and subscription — in a virtual way”, Mr Saunders added.

Column chart showing Lululemon’s growing revenues ($bn) since 2012

The deal is a rare purchase by a retailer in the pandemic, which has upended consumer spending trends.

Mirror, in which Lululemon first invested a minimal sum last year, has boomed during lockdown as housebound consumers have been unable to visit the gym. Still, the home exercise surge would have inflated the valuation of the lossmaking private company, backed by hedge fund manager Steve Cohen. Shares in Peloton, the listed exercise bike company, have more than doubled this year.

“It’s interesting that they’ve chosen to do this at the height of the market,” said Susan Anderson, US retail analyst at B Riley FBR in Virginia. “Clearly, they have confidence that this way of exercising is going to stick.”

Lululemon said it expected Mirror, founded by a former professional ballet dancer four years ago, to turn a “modest” profit next year, excluding expenses related to the acquisition.

The yogawear specialist, which is without a chief financial officer after PJ Guido left in May to join a car dealership chain, did not provide details of how it planned to do so, although Mr McDonald said the two businesses would prove complementary. He said the clothing chain would sell the exercise equipment in its stores, for instance.

Whatever the success of Lululemon’s integration of Mirror, Mr Saunders noted that the company remained part of a wider “wellness economy that has been growing for a very long time”.

“It’s definitely not a short-term fad. If anything, it’s really accelerating at the moment and Lululemon is at the heart of it.”