Lululemon Athletica Inc and the Apparel Industry - Research Paper Example

LULULEMON ATHLETICA INC. and the Apparel Industry [N a m e] Executive Summary This report analyzes the apparel industry of United States and one of the major players in the apparel industry, Lululemon. The report is divided into two broad segments; industry analysis and analysis of Lululemon. This report analyzes the financial position of the industry and company as well and identifies different factors that affect the industry. The trend of the industry and factors that might influence the industry in future has also been discussed in the report. The report identifies the stock price movement of the company and with the help of historical data of stock price of the company and stock price data of market; future predictions about the stock price movement of the Lululemon has been estimated. The report also analyzes the forecasted financial statement and earning per share of the company. Also the report recommends investors whether they should invest in the company and industry or not. Valuation of the company has been done in order to identify the value of Lululemon. Also it has been revealed that the performance of the company would improve in the years to come as the forecasted financial statements state the company would be able to increase its assets as well as improve its profitability in the years to come. Also the expected returns of the company’s stock are estimated to be higher than the average market return. INTRODUCTION Apparel industry is one of the most attractive industries for investors to invest because the demand of such industry has always been high. The industry also suffered because of financial crisis in the year 2007 and right now the industry is improving its position with the passage of time. The industry is very competitive with lots of brand names operating in the market like PVH, V.F. Corporation, Lululemon, Polo Ralph Lauren and Liz Claiborne and many others. This report analyses the current scenario of the industry and its future outlook. The second part of the report covers analysis of one of the key players in the apparel industry, Lululemon. Lululemon financial strength and position have been analyzed and its stock price movement has been observed to estimate the future stock price of the company. In addition to this, in the report contains valuation of the Lululemon and recommends investors whether the company is profitable or not. INDUSTRY AND COMPARATIVE ANALYSIS The performance of apparel industry has been ordinary in the second quarter of 2011. The performance of firms in the industry during first quarter showed mixed results as there were some firms like PVH and V.F. Corporation which were able to start their new year positively; though on the other hand, there were firms like Polo Ralph Lauren and Liz Claiborne that were not able to live up to the expectations. There were several factors responsible for the poor performance of these companies in the apparel industry however the main reason was increase in input costs, increase in selling and administrative expenses of the company and some inventory blunders. The same kind of performance was expected in the second quarter of 2011 however the results have been better as V.F. Group and Jones Group have shown positive growth. Still, stocks of some companies like Hanesbrands and Iconix Brand Group showed little improvements. Companies in the apparel industry are facing difficult situation particularly because of increasing operating costs which are restricting consumers thus limiting the sales of the industry. Increased cost of commodity and increasing wages have increased the overall cost of production of the companies in the industry and many companies are increasing their prices to maintain profit margin but still the reaction of customers will define the fate of the industry. Considering the potential growth of the industry, different companies have planned to open new stores in the years to come. Lululemon has also planned to open 22 to 27 new stores and the story of other brands in the market is very much similar as they have planned to open new stores to expand their sales. Total sales of the industry have been increasing except in 2009. The following table indicates the total sales of the apparel industry since 2007. Also industry sales of 2012 have also been forecasted . 2007 2008 2009 2010 2011 2012 Sales in million 38,775 39,262 36,823 42,124 44,500 46,725 FUTURE OUTLOOK OF INDUSTRY How the Industry Operates With the reduction in cotton price, companies would be able to reduce their cost of production. But despite of this reduction in cotton prices, there has been a significant increase in the wages, gasoline expense and selling and administrative expenses because of which the firms are forced to raise their prices. Thus with products being sold at a higher price, the response from the customers would play an important role and the future of different companies might not be as bright as it has been expected. Key Industry Ratios Production prices and cost of selling and administrative expense would play important role in defining the prices of the products and change in prices could affect the overall performance of the industry. Therefore firms that are able to produce at lower costs and sell quality products at lower prices would be able to gain market share. So, gross profit margin and operating margin are key ratios of this industry that would define the performance of the company. Statistics Along With Industry Trends Because of the increasing costs of labour and commodities, firms in the industry are expected to increase the price of the products in order to maintain their desired level of profit margin. According to Spencer (2011) the profit margin of the overall industry would be 7.5% in 2011 as well as 2012. Even though, this profit margin is higher since 2007 however the main reason for lowering profit margin in last few years was the financial crisis which had reduced the sales of the industry drastically. Currently the economy is recovering from the impact of financial crisis and therefore with the passage of time, the industry is going to improve further however the main factor that would determine the future of the industry is the reaction of customers once the firms in the industry increase their prices to maintain their profit margin. The relative strength of the overall industry is expected to improve further but gradually with the passage of time. The following image represents the relative strength of apparel industry since 2005. Recommendations for Making an Investment in the Industry As the economy is recovering from recession, the sales of the industry have started increasing and it is expected to improve even further with the passage of time. However, the increase in cost of production and other costs might impact the overall progress of the industry. Nevertheless, firms increasing the price would be able to maintain profit margin however firms that might not increase the price would be able to record higher sales thus gaining more profit but at a lower margin. ANALYSIS OF LULULEMON FORECASTS OF LULULEMON’S FINANCIAL STATEMENTS AND EPS Forecasting of Revenue In order to forecast the EPS of the company, first the forecasted financial statements of the company are to be prepared. Average growth in net revenue of the company has been forecasted using regression. The average growth in sales in the last 3 years is found to be 42.6%. Using the forecasting formula, the forecasted sales of company in 2012 and 2013 are expected to be $864,246 and $1,043,354. The graph 2 in the appendix section represents the net revenue of the company since 2009 as well as forecast net revenue of 2012. And 2013 Also a trend line has been shown (in black colour) indicating positive growth in revenue of the company. Adjustments to be made on Financial Statement before forecasting As the net revenue of the company has been forecasted, several other heads are to be calculated as well. To calculate the cost of goods sold of the company, the average ratio of cost of goods to net revenue in 2011, 2010 and in 2009 have been taken and the average ratio of Cost of goods sold since 2009 has been multiplied with the net revenue of 2012 and 2013 to calculate the forecasted cost of goods for the year 2012 and 2013. The same method has been applied to calculate different expenses and costs. In addition to this, the other income of the company has been calculated using the same method. The forecasted net incomes of the company for 2012 and 2013 have been estimated to be $119,541 and $144,315 respectively. FORECASTING OF ANNUAL REPORTS AND CASH FLOW STATEMENTS EARNING PER SHARE OF THE COMPANY IN 2012 AND 2013 The company has announced stock split in July, 2011 therefore the number of shares have been doubled from 2011. If the stock split had not occurred then the forecasted net basic EPS of the company in 2012 would have been $1.69 and the forecasted diluted earning per share would have been $1.66. However, as the stock split has occurred therefore the forecasted net basic EPS of the company would be $0.84 and forecasted diluted earning per share would be $0.83. Basic earnings per share in 2013 is expected to be $1.02 and diluted earnings per share is expected to be $1.0. It has been assumed that the stocks will remain same in 2012 and 2013. FORECASTING OF BALANCE SHEET AND CASH FLOW STATEMENTS The balance sheet and cash flow statements of the company for the year 2012 and 2013 have been estimated by taking the average growth rate of the performance of the company, to forecast the balance sheet of 2012 and 2013 balance sheets of the company since 2008 have been used however to forecast the cash flow statements of the company for 2012 and 2013, cash flow statements of the company since 2009 have been used. The historical performance of the company is an important factor that describes the future performance and thus, the past financial statements of the company have been used to predict the future financial statements of the company. ESTIMATION OF STOCK PRICE The stock price of the company has been improving since January 2009 as the economy started recovering from the impact of financial crisis. Before 2009, the stock price of Lululemon had been showing a negative movement. The graph 1 in the appendix section reflects the stock price movement of the company since 2007. However, as the stock split has been announced in July 2011 therefore to minimize the impact of stock split, the stock prices before July 2011 have been adjusted accordingly. In graph 1 in the appendix section, a polynomial trend line (black colored) has been made estimating the trend of the stock price movement of the company. This reflects that the stock price has been showing positive trend since the starting of 2009 and it would further increase with the passage of time. To have a better estimation of stock price movement, alpha and beta of the company has been calculated using the historical data of the company and NASDAQ since July 2007. Details of the calculation can be found in the appendix section. After calcualtions, value of alpha of Lululemon is equal to 0.038 and the value of beta is 2.242. As a result an equation can be prepared using these two values to identify the return of the stock which would also determine the stock movement of the company. The equation can be represented as follows Return of the company = 3.8% + [(2.242) * (Rm)] Where, Rm is the return of NASDAQ As the beta of the company is positive therefore the stock price would move with the same direction as of the market. So, as the market is currently recovering from recession therefore the overall market index is expected to improve thus the stock price would also improve. The expected price of stock in 2012 would be somewhere in the range of $65 to $75. PERFORMANCE OF NEW STORES Total revenue of the company has increased since 2004 from a figure of $40.7 million to $711.7 million in 2010. This reflects that there has been a accumulated growth of 61% during this time period. One of the main reasons for this increase in net revenue is because of the opening of new stores, Lululemon opened 23 retail locations in 2010, 7 stores in 2009 along with e-commerce sales channel. Also there were 35, 31, 14 and 17 stores opened in 2008, 2007, 2006 and 2005 respectively. With the growing demand of the products, the company has planned to open 22 to 27 new stores this year and this will help the company in increasing total revenue further. Revenues according to Market Canada has been the most profitable market for Lululemon followed by United States. The following table reflects the sales of the company segregated in terms of geographical markets. 2011 2010 2009 Canada 371,604 271,169 243,525 United States 323,477 181,144 109,844 Australia and Hong Kong 16,623 585 119 Total Revenue 711,704 452,898 353,488 Foreign Exchange Rate Risk As the most of the sales of the company comes from the Canadian market thus the company faces foreign exchange rate risk. The company also does not hedge the foreign currency thus changes in the exchange rate might cause risk to the actual profits earned. The aggregate gains (losses) because of foreign exchange in 2011, 2010 and 2009 have been $477, $174, and $(110) respectively. Thus with fluctuations in foreign exchange risk can affect the actual income of the company. Inventory Valuation Inventory is valued by the company using weighted average method. VALUATION OF FIRM In order to find out the value of the firm different techniques have been proposed. In this report, to calculate the value of Lululemon following methods have been used: Net Assets Value (NAV) Net Assets value represents the value of total assets minus liabilities of the company. NAV is calculated using the following formula: NAV = (Assets – Liabilities) NAV per share is also used to calculate or identify the net asset value of the company per share. It can be calculated by the following formula: NAV per share = (Assets – Liabilities)/ Total number of outstanding shares Total NAV of the company in 2011 is $394,293 and NAV per share of the company is $2.74. Market Capitalization The other method used for valuation of the firm is market capitalization in which the stock price is multiplied by the number of shares of the company. With current stock price equal to $54.66 and number of outstanding shares equalling 141,720, the value of the firm with market capitalization is $7,746,415. Price Earnings Multiple Valuation Market valuation of a firm is also calculated through price earning multiple valuation in which the P/E ratio of the company is multiplied with the net income of the company to get the market value of the company. Market value of Lululemon through this method is $4,655,939. Sensitivity Test Changes in the price of stock would change the market value of the company. For instance if the stock price of the company changes from $54.66 to $30 because of any reason, then the market value calculated through market capitalization will change significantly and it would become $4,251,600. Changes in price will also affect the value of Lululemon calculated through Price Earnings Multiple Valuation method. If the stock price is $30 then the value of the firm with Price Earnings Multiple Valuation method will be $2,555,400. Thus the stock price is an important factor that would determine the valuation of the company. Recommendation to Buy or Sell Lululemon’s Equity The share price of the Lululemon has been growing and stock has yield better returns than the returns of average market (NASDAQ). The graph 3 in the appendix section represents the return of NASDAQ and Lululemon since July 2007. Returns of both have been flcutuating, however more fluctuations can be observed from the graph 3 in NASDAQ then in Lululemon. With the stock expected to grow even further and the stock of Lululemon being less volatile than the average market return, therefore stock of Lululemon is an attractive for investors to add in their portfolio. Not only this, the beta of Lululemon is 2.242 thus representing better returns than the market. Work Cited Spencer, Mathew. “Apparel Industry.” Industry timeliness. Aug. 2011. 15 Nov. 2011. LULULEMON ATHLETICA INC. “Annual Report.” EDGAR Online. 2011. 15 Nov. 2011. Appendix INCOME STATEMENT 2013 2012 Net revenue 1,043,354 864,246 Cost of goods sold 502,869.61 416,544 48.20% Gross profit 540,484 447,702 Operating expenses: Selling, general and administrative expenses 324,731.92 268,987 31.12% Provision for impairment and lease exit costs 5,490.88 4,548 0.53% Income from operations 210,262 174,167 Other income (expense), net 2,344 1,942 0.22% Income before provision for income taxes 212,606 176,109 Provision for income taxes 68,290 56,567 6.55% Net income from continuing operations 144,315 119,541 Net income attributable to non-controlling interest - Net income attributable to lululemon athletica inc.  144,315 119,541 Net basic earnings per share 1.02 0.84 Net diluted earnings per share 1.00 0.83 Basic weighted-average number of shares outstanding 141,720 141,720 Diluted weighted-average number of shares outstanding 143,858 143,858 BALANCE SHEET ASSETS Average Growth Rate Forecasted Balance Sheet 2012 Forecasted Balance Sheet 2013 Current assets Cash and cash equivalents 96% $ 619,133.06 1211959.251 Accounts receivable 36% $ 12,421.45 16925.45467 Inventories 17% $ 67,486.37 79249.86021 Prepaid expenses and other current assets 38% $ 8,861.32 12253.89464 Assets of discontinued operations CURRENT ASSETS $ 707,902.20 $ 1,320,388.46 Property and equipment, net 19% $ 84,316.33 100195.0987 Goodwill and intangible assets, net 79% $ 48,435.77 86530.81736 Deferred income taxes 517% $ 48,741.62 300955.8353 Other non-current assets 55% $ 6,290.27 9738.499532 TOTAL ASSETS $ 895,686.18 $ 1,817,808.71 LIABILITIES AND STOCKHOLDERS EQUITY Current liabilities Accounts payable 22% $ 8,153.07 9982.36742 Accrued liabilities 76% $ 44,488.46 78335.445 Accrued compensation and related expenses 38% $ 23,252.60 32046.18586 Income taxes payable 113% $ 39,122.71 83188.56713 Unredeemed gift card liability 32% $ 23,965.70 31613.55134 Other current liabilities Liabilities of discontinued operations $ 138,982.55 $ 235,166.12 Other non-current liabilities 44% $ 28,290.38 $ 40,740.43 Deferred income taxes $ 167,272.93 $ 275,906.55 Stockholders equity Common stock, $0.01 par value, 200,000 shares authorized, issued and outstanding 53,378 and 51,126 7% $ 570.82 610.1780576 Additional paid-in capital 10% $ 197,477.02 216807.5494 Retained earnings 65% $ 313,486.01 518166.995 Accumulated other comprehensive income 88% $ 38,129.18 71515.29011 TOTAL STOCKHOLDERS EQUITY $ 716,935.96 $ 1,083,006.56 TOTAL LIABILITIES AND STOCKHOLDERS EQUITY $ 895,686.18 $ 1,817,808.71 Average Growth 2012 2013 Cash flows from operating activities Net income attributable to lululemon athletica inc. 109% 254743.25 532586.965 Net income attributable to non-controlling interest Net loss from discontinued operations Net income from continuing operations 110% 254743.25 254743.251 Items not affecting cash Depreciation and amortization 18% 29082.613 34362.4923 Stock-based compensation 30% 9418.8976 12197.942 Provision for impairment and lease exit costs 368% 8284.9182 38735.8181 Derecognition of unredeemed gift card liability -36% -905.55932 -583.2416 Deferred income taxes 2803% 326105.31 9466323.21 Excess tax benefits from stock-based compensation -304% 16025.601 -32661.82 Gain on investment Other, including net changes in other non-cash balances -22% 18654.406 -32661.82 Net cash provided by operating activities - continuing operations 53% 661409.44 9740455.83 Net cash provided by operating activities - discontinued operations SUM Cash flows from investing activities Purchase of property and equipment 96% -59466.184 -32661.82 Investment in and advances to franchise -100% Acquisition of franchises Net cash used in investing activities - continuing operations 163% -59466.184 -32661.82 Net cash used in investing activities - discontinued operations SUM -59466.184 -32661.82 Cash flows from financing activities Proceeds from exercise of stock options 383% 28171.13 135985.702 Excess tax benefits from stock-based compensation -304% -16025.601 32661.8199 Net cash provided by financing activities - continuing operations -617% 12145.529 168647.522 Net cash provided by financing activities - discontinued operations 12145.529 168647.522 Effect of exchange rate changes on cash 0 0 Increase in cash and cash equivalents 12145.529 168647.522 Cash and cash equivalents from continuing operations, beginning of year $ 316,286 $ 328,432 Cash and cash equivalents from continuing operations, end of year $ 328,432 $ 497,079 IMAGE Image 1 (Source: Spencer, 2011) GRAPHS Graph 1 Graph 2 Graph 3 Read More